US Treasury Secretary Scott Bessent has suggested that the Federal Reserve could consider increasing the capacity of a key emergency liquidity facility designed to help stabilize the Japanese yen amid periods of market volatility.

The facility in question is the Federal Reserve's Foreign and International Monetary Authorities (FIMA) Repo Facility, which allows foreign central banks and international monetary authorities to exchange their holdings of US Treasuries for US dollars. The mechanism serves as a backstop liquidity tool, enabling foreign central banks to obtain dollar funding without having to sell Treasury securities outright in the open market, thereby helping to prevent disorderly selling that could disrupt global financial markets.

Bessent noted that global bond markets have expanded significantly since the FIMA facility was first established, implying that the current parameters of the facility may warrant revisiting in light of the growth in market size and trading volumes. The facility currently operates with a per-counterparty limit of $60 billion, a ceiling set at its inception in 2020.

The FIMA repo facility was created by the Federal Reserve in March 2020, during the height of the COVID-19 pandemic, to address severe dollar shortages in global markets. At the time, the sudden global dash for dollars placed intense pressure on foreign central banks, particularly those holding large reserves of US Treasuries. The facility allows eligible foreign central banks to temporarily exchange their Treasury holdings for dollars through repurchase agreements, with the Treasuries returned once the repo matures.

By providing a reliable source of dollar liquidity to foreign central banks, the FIMA facility is designed to protect the US economy from financial stress originating overseas. When foreign central banks can access dollar funding through the facility, it reduces the likelihood that they will need to liquidate Treasury holdings in large volumes, which could drive up US borrowing costs and destabilize the market for US government debt.

The yen has experienced episodes of heightened volatility, drawing attention to the role that emergency liquidity mechanisms such as the FIMA facility can play in mitigating cross-border financial spillovers. The pressure on the yen has been compounded by the wide interest-rate differential between the United States and Japan, as the Bank of Japan only recently ended its prolonged era of negative interest rates while the Federal Reserve had raised rates aggressively. Japan holds over $1 trillion in US Treasuries, making it the largest foreign holder of US government debt and giving the FIMA facility particular relevance for Japanese authorities managing currency stability. Japan's Ministry of Finance has conducted currency market interventions on multiple occasions in recent years to counter yen weakness, underscoring the practical importance of dollar liquidity arrangements. Bessent's remarks suggest a willingness within the US Treasury to explore adjustments to the facility's capacity to better reflect the current scale of global bond markets.

Source: Economic Times Markets