Evercore: The Federal Reserve's "unpopular" liquidity tools may ease Japan's pressure to sell U.S. Treasuries, but prolonged use may test the markets' faith in U.S. and Japanese intervention.

Evercore ISI's latest report indicates that a rarely used liquidity tool by the Federal Reserve, the Foreign and International Monetary Authorities (FIMA) Repo Facility, could help Japan avoid large-scale sell-offs of U.S. Treasury bonds when intervening in the currency market to support the yen. However, the agency warns that relying on this tool in the long term could instead prompt the market to test the determination of both Japan and the U.S. to stabilize the exchange rate. The FIMA Repo Facility allows overseas central banks and official institutions to obtain dollar liquidity from the Federal Reserve by using their holdings of U.S. Treasury bonds as collateral, without needing to directly sell Treasuries in the open market to raise funds. This tool was introduced during the pandemic in 2020 to assist overseas official entities in obtaining dollar financing while minimizing the impact on the U.S. Treasury market, and it officially became a long-term mechanism in July 2021. However, Evercore ISI strategists Marco Casiraghi and Gang Lyu point out that the scale of usage for this tool is significantly limited. According to regulations, each counterparty can obtain a maximum of $60 billion in financing per day, which is only slightly higher than the amount of funds the Japanese government used for currency intervention last Thursday. Therefore, the FIMA tool is more suitable for providing short-term liquidity support, making it challenging to meet the funding needs for sustained, large-scale currency intervention. The two strategists stated, We believe the market may focus on this Federal Reserve repo tool with a cap on its limits, which could backfire and prompt the market to test whether the U.S. and Japan are willing to support the yen through large-scale sales of U.S. Treasuries. Data shows that this tool is typically underutilized. As of the week ending July 29, its average usage balance was only about $6 million; the last significant use was in early February, when the financing scale was around $3 billion. Japanese Finance Minister Shunichi Suzuki previously confirmed that Japan conducted yen-buying intervention last Friday and stated that it would use the FIMA Repo Facility for funding support in the future. U.S. Treasury Secretary Janet Yellen also expressed support on social media for Japans use of this tool and suggested appropriately increasing its usage limit. According to Federal Reserve rules, any adjustments to the scale of the FIMA tool require approval from the Foreign Currency Subcommittee of the Federal Open Market Committee (FOMC) and must be communicated to the entire FOMC. Evercore ISI further points out that the FIMA tool is essentially a short-term liquidity support mechanism, not a long-term financing channel, and thus must be continually rolled over to maintain the funding source after loans mature. Additionally, the financing cost of this tool is relatively high, with the current interest rate at 3.75%, while the cost of seven-day financing during the same period is approximately the overnight index swap (OIS) rate plus 25 basis points. Strategists indicate that the Federal Reserve intends to set the financing cost of the FIMA tool higher than the financing costs in the private repo market, which reflects its positioning as a liquidity support tool during periods of market stress, rather than for everyday financing or long-term, large-scale currency intervention.