The dollar "nuclear button": If Trump targets the Federal Reserve's "swap arrangements"

In 2025, Trump repeatedly used tariffs to advance his geopolitical and economic goals. UBS pointed out that the dollar swap lines are far more deterrent than tariffs.

On March 27, UBS's report indicated that the Federal Reserve's dollar swap lines are a key tool for maintaining global financial stability, far more influential than tariffs. The dollar swap mechanism controls a foreign exchange swap market worth approximately $97 trillion, equivalent to the total global GDP.

If Trump targets the Federal Reserve's dollar swap as a "nuclear button"—refusing to provide dollar liquidity at critical moments would trigger a severe global financial crisis, but it would also accelerate the world's de-dollarization process.

UBS analysts stated that dollar swap lines are the last line of defense for global financial stability. The main way for non-U.S. entities to obtain dollar liquidity is not through U.S. imports, but through the foreign exchange swap market. Foreign exchange swaps essentially involve dollar loans collateralized by foreign currencies, where non-U.S. counterparties borrow dollars by swapping their local currency. Although the foreign exchange swap market is large, it has relatively low credit risk because it involves the full principal exchange at the start of the transaction.

UBS emphasized that despite the relative safety of the foreign exchange swap market, there is a significant risk: most foreign exchange swaps have short maturities, while the corresponding dollar assets have longer maturities, creating a huge asset-liability maturity mismatch. When U.S. banks face pressure or a global financial shock occurs, banks may be unwilling or unable to roll over these collateralized short-term dollar loans, leading to a liquidity crisis.

The Federal Reserve's dollar swap lines are a double-edged sword

The report emphasized that if the Federal Reserve refuses to provide liquidity support during global financial stress, the consequences will be extremely serious. UBS provided an example:

If the Federal Reserve had not intervened during the 2008/9 financial crisis and the pandemic, the reserves of foreign central banks and international lending institutions such as the International Monetary Fund (IMF) might not have been sufficient to meet global dollar demand, leading to a further spike in dollar borrowing costs compared to the situation at that time, resulting in defaults and potentially systemic impacts on the global financial system.

Wall Street Journal reported that during the dollar liquidity crisis triggered by the pandemic in 2020, after the Federal Reserve restarted liquidity during the three major financial crises, it further launched monetary stimulus and expanded the counterparties eligible for temporary dollar liquidity swaps.

UBS stated that while the responsibility for extending dollar swap lines lies with the Federal Reserve rather than the U.S. government, the government can still indirectly exert influence through moral persuasion and the appointment of Federal Reserve Board members. However, this approach is also a double-edged sword for the U.S. itself:

• In the short term, the tightening of U.S. dollar liquidity will lead to an increase in dollar financing costs and a significant appreciation of the dollar, but financial pressure will also spread to the U.S. financial system.
• Additionally, since foreign exchange swaps are often used to hedge U.S. assets, this may lead to a sell-off of U.S. assets (such as U.S. MBS or government bonds), ultimately harming the U.S. market itself.

Long-term Impact, Accelerating the De-dollarization Process

UBS analysis states that if Trump targets the Federal Reserve's dollar swap mechanism, such as the Fed selectively using swap lines as leverage to achieve other policy goals, it will lead to an expansion of cross-currency basis, which will marginally support the dollar.

However, UBS emphasizes that the medium-term consequences of this are more severe. The Federal Reserve's withdrawal from its role as the international lender of last resort is equivalent to suspending the dollar's status as the world's safest currency.

The market will doubt the Federal Reserve's commitment to maintaining dollar liquidity—especially towards major allies—which will accelerate efforts by countries to reduce their dependence on the U.S. financial system;

Ultimately leading to a decrease in U.S. assets held by foreigners and a general weakening of the dollar's role in the global financial system.

It is noteworthy that UBS points out that China and Russia do not have access to the Fed's swap lines; they strengthen their financial systems through large official reserves accumulation or de-dollarization.

If this concern spreads to U.S. allies, it could create the strongest impetus for global de-dollarization since the establishment of the post-war global financial architecture.

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