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Rising dollar points to risks in global market
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AS the US dollar hits record highs, it is no longer a sign of global recovery but also becoming the world’s premier fear gauge and a global risk.
Recently, the US dollar hit a 13-year high. The ICE Dollar Index, which measures the currency against a basket of six other currencies, soared to 100.6, the highest reading since April 2003. According to many analysts, the US dollar is fueled by rising government bond yields (and the Fed’s anticipated rate hike), and expectations of president-elect Donald Trump’s fiscal expansion plans (in the form of infrastructure stimulus).
Furthermore, as the dust settles after Trump’s triumph, the magnitude of the win — which ensures a Trump White House, a Republican Senate and a Republican House — translates into the kind of political consolidation that America has not witnessed in generations.
If Republicans find unity and Democrats remain fragmented, Trump could have a major opportunity to promote policies that would further stimulate the US economy, growth and the dollar.
However, the future path of the US dollar may not prove as rosy as anticipated. Recently, the Bank for International Settlements (BIS) — a sort of a think-tank of central banks — released an intriguing report, which argues that the US dollar has replaced the volatility index as the “new fear index.”
The leading barometer of risk appetite and leverage used to be the VIX (or the Chicago Board Options Exchange volatility index). Before the 2008-9 financial crisis, there was a close correlation between leverage and the index. When the VIX was low, the appetite for borrowing went up, and vice versa. As a result, the VIX soared to a record 80.9 some eight years ago.
After years of ultra-low interest rates and multiple rounds of quantitative easing that remain in effect in Europe and Japan, one would expect the VIX to be rising again. And yet, it has averaged 16 over the past year.
Monetary easing by the world’s leading central banks in advanced economies have suppressed volatility for stocks, while compressing credit spreads.
In the process, the VIX’s predictive power has diminished, while the US dollar has become the indicator of risk appetite and leverage. This dynamic has distressing implications as it has pushed international borrowers and investors toward the dollar, with dollar appreciation exposing borrowers and lenders to valuation changes.
The recent dollar rally may not precipitate market confidence, but new risks.
Time to buckle up
Today, the US is the world’s greatest debtor nation and its sovereign debt has soared to US$19.9 trillion. In the past, foreign investors have played a vital role in financing US deficits. Yet, in the past year, foreign central banks have sold almost US$375 billion in Treasuries. Among the major sellers are China, which now holds the lowest amount of US debt since 2012 (US$1.16 trillion), and Saudi Arabia, which has sold almost 30 percent of its US debt holdings in the past nine months. Recently, the US Federal Reserve’s second-in-command Stanley Fischer announced that dollar liquidity is “adequate.” Yet, market skeptics have highlighted dollar illiquidity issues for several years.
If they are right, then the Fed rate hikes will boost the price of the US dollar, with the rising dollar tightening economic conditions worldwide. Instead of the expected Trump inflation, that would mean increasing deflationary constraints.
That would result in a chorus of criticism of the current dollar-based system by the large emerging economies (i.e. the BRICS nations). They would point out that the fundamentals of the US economy do not support US market valuations and the US dollar. Instead, the most-traded currency worldwide poses rising risks, particularly to the world’s fastest-growing emerging economies which today fuel much of global growth.
What’s good for the US dollar may not be that good for the world economy.
Dr Steinbock is the founder of Difference Group and has served as research director at the India, China and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Center (Singapore).
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