Today we return to a topic which has been regularly in the headlines in 2018. We started the year with the US administration that looking like it was talking the US Dollar lower in line with its America First policy. Back on the 23rd of January we were mulling this.
“Obviously a weaker dollar is good for us as it relates to trade and opportunities,” Mnuchin told reporters in Davos. The currency’s short term value is “not a concern of ours at all,” he said.
However as the year has gone by we have found ourselves mulling what the US Treasury Secretary said next.
“Longer term, the strength of the dollar is a reflection of the strength of the U.S. economy and the fact that it is and will continue to be the primary currency in terms of the reserve currency,” he said.
If we look at matters from the perspective of the Euro then the 1.20 of the opening of 2018 was fairly quickly replaced by 1.25. But since then the US Dollar has rallied and has moved to 1.15. Some of that has been in the past few days as it has moved from 1.18 to 1.15. That recent pattern has been repeated across most currencies and at 114 the US Dollar us now up on the year against the Yen as well. The UK Pound has suffered this year from a combination of the Brexit process and the machinations of the unreliable boyfriend but it too has been falling recently against the US Dollar to below US $1.30 whilst holding station with other currencies.
Year end problems
The currency moves above are being at least partly driven by this from Reuters.
As the Fed raises interest rates and reduces its balance sheet, and the dollar and U.S. bond yields move up, overseas investors are finding it increasingly difficult and costly to access dollars. That much is obvious. What’s perhaps more surprising – and potentially worrying – is just how expensive and scarce those dollars are becoming.
So with US Dollar scarce it seems that some have been dipping their toes into the spot currency markets as a hedge. This is because other avenues have become more expensive.
Until this week the cross-currency basis market, one of the most closely-watched measures of broad dollar demand, liquidity and funding, had showed no sign of stress. Demand for offshore dollars was being met easily and at comfortable prices.But the basis widened sharply on Thursday, the day after the Fed raised rates for the eighth time this cycle and signalled it fully intends to carry on hiking. In euros, it was the biggest one-day widening since the Great Financial Crisis.
So last week there was a type of double whammy of which the first part came from the US Federal Reserve.
In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 2 to 2-1/4 percent.
So US official interest-rates have risen but something else has been happening.
Three-month dollar funding costs are currently running around 2.50 pct. Not high by historical standards and, on the face of it, surely manageable for most borrowers. But it is heading higher, and the availability of dollars is shrinking.
So as you can see a premium is being paid on official interest-rates. So we have higher interest-rates and a more expensive currency. We know that in spite of the official rhetoric that various countries are moving away from dollar use the trend has been the other way. From Reuters again.
All this at a time when the world’s reliance on the dollar has never been greater. Its dominance as the international funding currency has grown rapidly since the 2008 crisis, especially for emerging market borrowers.
Dollar credit to the non-bank sector outside the United States stood at 14 percent of global GDP at the end of March this year, up from 9.5 pct at the end of 2007, according to the Bank for International Settlements.
Dollar lending to non-bank emerging markets has more than doubled to around $3.7 trillion since the crisis and a similar amount has been borrowed through currency swaps.
Regular readers will recall that back on the 25th of September I took a look at the potential for a US Dollar shortage as we face a new era.
The question to my mind going forwards is will we see a reversal in the QT or Quantitative Tightening era? The supply of US Dollars is now being reduced by it and we wait to see what the consequences are.
Indian problems
The largest country in the sub-continent has been feeling the squeeze in several ways recently. One has been the move away from emerging market economies and currencies. Another has been the impact of the fact that India is a large oil importer and the price of crude oil has been rising making the problem worse. This morning’s move through US $86 for a barrel of Brent Crude Oil may fade away but over the past year we have seen a rise of around 53%. For the Indian Rupee this has been something of what might be called a perfect storm as it has found itself under pressure from different avenues at the same time. Back on the 16th of August I looked at the Indian crude oil dependency and since then the metric have got worse. The price of oil has risen further and partly in response to that the Rupee has weakened from 70 to the US Dollar which was a record low at the time to 74 today.
Accordingly I noted this earlier from Business Standard.
The Reserve Bank of India (RBI) on Wednesday allowed oil-marketing companies (OMCs) to raise dollars directly from overseas markets without a need for hedging.
In a post-market notification, the RBI said the minimum maturity profile of the borrowings should be three years and five years, and the overall cap under the scheme would be $10 billion. The central bank relaxed criteria for this.
It gives us a guide to the scale of the Indian problem.
The oil-swap facility was much anticipated in the market, as that would have taken the pressure away from the market substantially. Annually, the dollar demand on oil count is $120 billion, or about $500 million, on a daily basis for every working day.
And the driving factor was a lack of US Dollar liquidity
The RBI announcements on liquidity are more focused towards providing relief to the NBFCs (non-banking financial companies) and banks, rather than cooling of the rupee in the FX markets,
Let us move on after noting that the Reserve Bank of India may have had a busy day.
Currency dealers say the RBI intervened lightly in the market.
Comment
Overnight we have seen news regarding a possible impact on the US treasury bond market which is for holders a source of US Dollars. From Janus Henderson US.
Euroland, Japanese previous buyers of 10yr Treasuries have been priced out of market due to changes in hedge costs. For Insurance companies in Germany / Japan for instance, U.S. Treasuries yield only -.10% / -.01%. Lack of foreign buying at these levels likely leading to lower Treasury prices.
This has impacted the US treasury bond market overnight and prices have fallen and yields risen. The ten-year Treasury Note now yields 3.21% instead of 3.15%. That does not make Bill Gross right ( he was famously wrong about UK Gilts being on a bed of nitroglycerine ) as the line of least resistance for markets would be to mark them lower in price terms and see what happens. Try and panic some into selling.
As to the yield issue which may seem odd the problem is that the cost of currency hedging your position is such that you lose the yield. Thus relatively high yielding US Treasuries end up being similar to Japanese Government Bonds and German Bunds.
As ever when there are squeezes on it is not so much the overall position which is a danger but the flows. For example India’s pol problem is good news for oil exporters but if they are not recycling their dollars then there is an imbalance. I guess of the sort which is why this temporary feature became permanent.
In November 2011, the Federal Reserve announced that it had authorized temporary foreign-currency liquidity swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank.
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