By Jamie McGeever

ORLANDO FL (Reuters) – Global markets are likely to collapse under the pressure of high levels of volatility and stress.

An over-inflated dollar can reflect and even fuel financial market stress. It could lead to a vicious cycle where a rush for dollars increases, global financial conditions tighten, and volatility is increased.

This is not just a reflection of how aggressive investors think the Federal Reserve will raise interest rates; it’s also an indication how dispersed the global central banks landscape.

The U.S. Monetary Authority appears to be ready for the largest tightening cycle in 1994 in both speed and scale, but others are in different stages and have different appetites for fighting inflation.

This Fed’s plan is quite distinct from its other three major peers. The Japanese and Chinese central banks are still encouraging easing, while the European Central Bank is likely to struggle in tightening amid fears of a Ukraine-related economic shock.

No matter what path the central banks choose, global inflation has exploded and there is no coherent policy response. Global market volatility has risen to the surface. U.S. Treasuries implied volatilty is at its highest level since 2009. In addition, global financial conditions have been the most tightened in thirteen years.

Bank of America analysts (NYSE:) say that after two years of global pandemic-fueled quantitative easing, $11 trillion has ended. The ‘volatility Anchor’ in the markets is now removed. It threatens disorderly movements in rates and currencies, which policymakers desperately want to avoid.

BofA’s Friday statement stated that “market panics” are frequently associated with divergent central banking policy objectives.

Graphic: Dollar and Fed tightening cycles – https://fingfx.thomsonreuters.com/gfx/mkt/dwvkryqdmpm/DOLLARFED.jpg

Graphic: Dollar and US recessions – https://fingfx.thomsonreuters.com/gfx/mkt/gkplgkqwovb/DOLLARRECESSION.jpg

1 TRILLION USD DEBT

Since 2002, the, which measures the value of the greenback against six major currencies is at its highest level. While it rose quickly this year and might be due to profit-taking, analysts still believe that it can appreciate more.

It is now more expensive for international borrowers to pay dollar-denominated bonds. A stronger dollar will make it harder. Institute of International Finance forecasts that well above $1 trillion of dollars worth of debt in emerging countries will be matured by next year.

Global financial markets have been hit hard by rising dollars and high U.S. borrowing prices. The global market just saw its worst performance in January and April since 1930s. U.S. bond volatility and Goldman Sachs’ global financial conditions index (NYSE:) are at their highest levels since 2009.

Additional problems for policymakers are the unrationality of financial markets and their herd-like behaviour. When currency traders see weakness or fracture they will go after the jugular. Market overshoots could lead to underlying economic problems.

Isabel Schnabel (ECB Executive Board member) spoke on March 17 about the danger of allowing political divergence too to spread.

She warned that a reaction function different from the one of the other central banks in the face of a prolonged period of high-target inflation could increase the impact of the shock on energy prices and weigh on the exchange rate.

Chris Marsh, Exante Data’s senior advisor, is an ex-economist at the International Monetary Fund.

If the ECB or other institutions don’t keep pace, they will end up importing inflation. The inflation rate is already extremely high. Marsh stated that it would be difficult for the Fed to keep pace with inflation.

Graphic: Dollar and G3 yield spreads – https://fingfx.thomsonreuters.com/gfx/mkt/zjpqkmdjzpx/DOLLARSPREADS.png

Other columns:

Following what happened, emerging markets are afraid of a 1994 Fed redux (Reuters April 25).

A global liquidity crunch is caused by a inflated dollar

The yen outlier distorts the bullish view of hedge funds on dollar (Reuters, April 18, 2018)

Euro FX reserves demand has returned after many years of neglect (Reuters April 13).

(The views expressed in this article are the opinions of the author. He is a columnist with Reuters.

(By Jamie McGeever, Editing by Andrea Ricci