Yearend stress catalyzed by a restive dollar: Mike Dolan
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[November 24, 2021] By
Mike Dolan
LONDON (Reuters) -As the good and great of
the investment world try to figure out 2022, they may have taken their
eyes off the rest of this year.
All of a sudden, the coming yearend -- often an illiquid and erratic
period for global markets once the U.S. Thanksgiving holiday is over --
looks incredibly stressful.
Much of that is seeded by the long-brewing narrative around
post-pandemic inflation, a more urgent "normalisation" of central bank
settings and a wide divergence in approaches from region to region - not
least due to different responses either side of the Atlantic to more
waves of COVID-19.
Clarity over Jerome Powell's renomination as Federal Reserve chief this
week might have been a moment that calmed things down. But all it seems
to have done is release more anxiety about recent Fed signals about
hastening a taper of its bond buying and possibly bringing forward a
first interest rate rise.
So much so that in the space of just three weeks money markets have
rushed to price three full quarter-point Fed hikes in 2022 compared to
the two seen at the start of the month. And they have also pulled in Fed
"lift-off" day to May from July.
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While all that may just be second-guessing next year, the market
repricing has its main impact now and nowhere more obviously than a
super-charged U.S. dollar around the world.
A rewriting of Fed scripts has only been matched by a scramble to
upgrade dollar forecasts by numerous global banks from Goldman Sachs and
Citi to HSBC and Deutsche Bank.
A host of political flashpoints worldwide have underlined a bid for
perceived dollar safety and liquidity. The picture includes mid-winter
energy stress over high oil and gas prices and how to react; rising
military tensions in Europe between NATO and Russia over Ukraine and
Belarus and even fractious relations between the West and China over
Taiwan and militarisation of space.
Wild swings in emerging currencies reflect the tremors.
A self-contained inflation black spot, policy conundrum and geopolitical
worry all on its own, Turkey - who's lira has lost 85% of value against
the dollar over the past decade - saw the dollar exchange rate balloon
more than 10% on Tuesday alone, clocking a rise of more than 40% so far
this month.
Turkey's lira may be a longtime outlier and an extreme example. But
emerging currencies from South Africa's rand or Poland's zloty and
Hungary's forint all hit their lowest for the year this week.
And it's not just the currencies of developing economies. The dollar's
index against the other major currencies hit its highest since July
2020, while the greenback hit its highest in four years against Japan's
yen and 2021 highs against the euro and sterling.
UNCORKED
Volatility has been uncorked everywhere, with aggregate measures of
foreign exchange volatility the highest since March and bond market
equivalents the highest in almost 20 months.
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A U.S. one dollar banknote is seen in this illustration taken
November 23, 2021. REUTERS/Murad Sezer/Illustration
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And as the Fed gets tough, still deeply negative real, or inflation-adjusted,
bond yields have finally broken higher - undermining presumed inflation hedges
such as gold and crytocurrencies and whipping away a key bulwark of expensive
Big Tech equity valuations. Even the long-dormant VIX of Wall St stock market
volatility has twitched back into life.
On top of this "valuation effect" the rate rise speculation and bond market
moves this week saw bond yield curves that measure the gap between 2 and 30-year
yields flatten to their lowest since shortly after the U.S. election last year
-- flagging growth concerns ahead and seeing the Nasdaq put in its worst two
days in two months.
"Interest rate sensitivity came back roaring yesterday pushing down all of our
growth baskets," said Saxo Bank's equity strategist Peter Garnry, adding there
was now potential for a 10% correction in U.S. tech stocks if Treasury yields
returned to the March highs.
And all this comes at time when dollar funding around the world tends to get
seasonally sticky anyhow, even before you deal with the ebbing tide of world
liquidity.
Dollar funding costs outside the United States hit their highest in almost a
year this week, with spreads on 3-month euro-dollar and yen-dollar cross
currency basis swaps at their widest since December 2020.
But TS Lombard economist Shweta Singh said the FX swap market may no longer even
be best measure of dollar funding stress as dollar liquidity ebbs from here.
She points out the recent abundance of dollars due to Fed bond buying, emergency
facilities and other related expansions of U.S. bank reserves meant offshore
borrowers had been tapping domestic money markets more than offshore swaps. This
shift had started before COVID-19 as U.S. multinational tax changes in 2017
forced substantial repatriation of huge pools of dollars parked overseas.
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As a result, direct changes to interbank funding associated with the Fed rate
rethink, liquidity reduction and exchange rate fallout could have a much more
direct impact around the world going forward.
"The Fed's large balance sheet, standing repo facilities, and swap lines have
meaningfully mitigated the ripple effects from a strong dollar to global
financing conditions, but they have not eliminated the impact from a
strengthening greenback on offshore dollar funding," Singh told clients.
(by Mike Dolan, Twitter: @reutersMikeD; editing by David Evans)
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