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Column-Yearend stress catalyzed by a restive dollar: Mike Dolan -Breaking


© Reuters. This illustration was taken on November 23rd, 2021. It shows a U.S. $1 banknote. REUTERS/Murad Sezer/Illustration

Mike Dolan

LONDON, (Reuters) – The good and the great in the investment industry are trying to work out 2022. They may be ignoring the remainder of 2018.

The coming yearend, which is often an unpredictable and volatile period for global markets after the U.S. Thanksgiving Holiday has ended, suddenly looks extremely stressful.

This is largely due to the persistent narrative surrounding post-pandemic inflation, an urgent normalisation of central bank settings and wide divergence between regions – not to mention the different responses on either side of Atlantic to the more COVID-19 waves.

The moment of clarity over Jerome Powell’s nomination as Federal Reserve Chief this week may have brought some relief. However, it only seems to have increased the anxiety surrounding recent Fed signals that they are accelerating tapers of their bond buying and possibly pushing for a first rise in interest rates.

It is so fast that the markets have priced three complete quarter-point Fed rises in 2022 in three weeks, as opposed to two in July. The Fed has also “lifted off” July to May.

Even though all of that is second guessing, market repricing still has an important impact and it’s not more obvious than a hyper-charged U.S.$ around the world.

Many global banks, from Citi and Goldman Sachs (NYSE:), have scrambled to improve dollar forecasts. Deutsche Bank (DE:).

Worldwide, a host of political crisis points have highlighted the desire for dollar safety. This includes the mid-winter energy crisis over high prices of oil and gas and how to respond; increasing military tensions between NATO and Russia over Ukraine, Belarus, and even fraught relations between China and West over Taiwan and militarisation in space.

The tremors are reflected in wild swings of emerging currencies.

Turkey, which has been a self-contained inflation black spot and policy dilemma, as well as a geopolitical concern all its own, saw its dollar exchange rate rise more than 10% Tuesday, the highest level since February, with a total increase of over 40%.

This may not be the norm, but it is an exception. This week, emerging currencies such as the zloty of Poland or Hungary and forint from Hungary all reached their lowest levels for the year.

It’s not only the currencies from developing countries that are affected. While the dollar index against major currencies reached its highest level since July 2020 it also reached its highest levels in four years, against Japan’s currency yen and against sterling 2021 highs. Dollar rises as Fed rate speculation mounts, Volatility rises with dollar, Dollar cross currency swaps spreads rise into yearend,


Volatility was uncorked everywhere. The aggregate measure of foreign exchange volatility has been at its highest point since March. Bond market equivalents have seen their peak in 20 months.

As the Fed becomes more aggressive, even though they are still very negative real or inflation-adjusted bond yields, they have finally broken higher. This has undermined presumed inflation hedges like gold and crytocurrencies, and shattered a critical bulwark against expensive Big Tech equity valuations. Wall St’s long-dead stock market volatility has come back to life.

This “valuation effect”, along with rate rise speculation, bond market movements this week saw the bond yield curves measuring the gap between 2- and 30-year yields fall to their lowest level since just after last year’s U.S. elections. It is raising concerns about future growth and causing the Nasdaq to post its worst performance in over two months.

Peter Garnry of Saxo Bank said yesterday that interest rate sensitivity returned roaring yesterday, pushing down all our growth baskets. He added there was potential for a 10% correction U.S. stocks if Treasury yields reverted to March highs.

This all happens when the dollar liquidity is eroding around the globe.

Dollar funding costs in the United States were at their highest level for almost one year, and spreads on three-month Euro-dollar and cross-currency basis swaps of yen dollars reached their largest since December 2020.

Shweta Singh, a TS Lombard economist, said that FX swap markets may not even be the most accurate measure of dollar funding stress. Dollar liquidity ebbs away from here.

The recent surge in dollars, due to Fed bond purchases and emergency facilities, meant that offshore borrowers were tapping into domestic money markets at a higher rate than those using offshore swaps. The shift was already underway before COVID-19, when U.S. multinational tax reforms in 2017 required substantial repatriation from large pools of dollars overseas.

Therefore, changes in interbank financing that are directly related to the Fed rate review, liquidity reduction, and currency fallout may have an even greater impact on the global economy.

Singh stated that “the Fed’s huge balance sheet and standing repo facilities as well as swap lines have significantly mitigated the ripple effect of strong dollars to global financing conditions but have not eliminated the impacts from strengthening greenbacks on offshore dollar funding.” TS Lombard chart on dollar use around the world, Lira and other EM currencies, US-Euro zone Economic Surprises and Euro,

(by Mike Dolan. Twitter (NYSE::): @reutersMikeD. Editing by David Evans