The Fed told the world on Feb 3rd, 2009 that they would be extending the currency swap facilities and issuing more USD through the arrangements to most of the worlds largest central banks. A swap is an agreement in which the Fed trades US Dollars for an equivalent value of the other central bank’s currency. For example, the Fed may trade $20 billion for 23 billion Swiss francs at today’s exchange rate. Why would the Fed do this and what does it mean for the value of the dollar versus the other majors?

[VIDEO] Fed Currency Swaps and the U.S. Dollar

The bank of Japan announced late last week that its U.S. dollar funds-supplying operations will also be conducted for an extended period. The BoJ had delayed taking part in the announcement on Feb 3rd until its policy meeting was complete later in the month.

Trading currency like this is supposed to increase the supply of dollars so that other central banks can auction and distribute them to their own commercial banks. Increasing the supply of dollars should help ease the credit market in these other countries.

This is needed because many commercial transactions around the world are done in dollars rather than the domestic currency so the supply of dollars is a critical component in running a smooth economy. The Fed’s actions are largely seen as being very supportive for stimulus plans taking shape around the world and in the U.S. itself.

The injection of dollars in exchange for foreign currency is also very supportive from a fundamental perspective for the USD itself. The dollar has been strengthening in recent months and has begun to channel in a consolidation over the last few weeks. The signal here is that there is still strong demand for USD, which can help traders think about what direction they should be looking for trades.