COLUMN-Dollar builds another steam head: Mike Dolan
(The author is editor-in-chief for finance and markets at Reuters News. All opinions expressed here are his own)
LONDON, July 2 (Reuters) – Confusing consensus once again, the dollar is building a new head of steam – a shocking prospect for those who see it as a harbinger of financial strains as well as an aggravating one.
Even though speculative bets on a weaker dollar were pruned in June and the collective size of that punt is a third of what it was in January, there remains a substantial net short position against the greenback – a position that persisted throughout the pandemic.
Forecasters in the latest Reuters polls, on average, continue to see further dollar weakness late in the year.
But the dollar will not fold.
It bamboozled most currency experts with an increase in the first quarter. And although some of the heat came out afterwards, it is back to its highest level since early April against most of the major peers – the pound, euro, yen and Swiss franc.
On some level, that shouldn’t come as a big surprise. Few doubt that the Federal Reserve is increasingly hawkish when other G7 central banks are clearly not. And the Fed may well signal some reduction in its currency printing over the next 3 months.
A disturbing new wave of COVID-19 variants in Europe and across Asia could delay the lifting of travel restrictions at least there and block a much-vaunted expansion of post-pandemic recovery beyond the United States .
And real, or inflation-adjusted, transatlantic yield spreads have again been more favorable to the dollar in recent weeks.
Even in the realm of political risk, the third quarter could give the euro more oomph as Germany goes to the polls in September, the pound grapples with the thorny realities of Brexit and the yuan braces for more of American-Chinese tensions.
So why the perplexity and the continuation of bearish bets?
For asset managers, the persistent ebb and flow of the pandemic will not prevent its eventual end through vaccination. As the world recovers, many assume that investors already focused in tech-heavy US stocks or Treasury bonds will eventually seek more value elsewhere.
For these reasons, Lombard Odier’s investment director, Stéphane Monier, places the “moderate” depreciation of what he considers a 20% overvalued dollar as one of the top 10 “condemnations” for the second half of the year – with however, warnings about an even more hawkish or harsher Fed. waves of COVID.
If so, the dollar’s renewed strength may be just fleeting and connected mid-year calendar adjustments or even just apprehension ahead of this week’s June jobs report on Friday.
But are there other things brewing in the background.
Some analysts are starting to examine the fallout from the overwhelming influx of liquidity into U.S. money markets – due to a combination of zero Fed policy rates, outstanding bond purchases and the U.S. Treasury squeezing its account general oversized (TGA) to the Fed under $ 500. billion by August.
The reduction in the TGA of more than $ 1.7 trillion at the end of last year temporarily replaced new sales of treasury bills as a way to fund pandemic relief and fiscal stimuli due to the August 1 deadline for extending the federal debt ceiling.
But its balance sheet, which has at least $ 220 billion to go this month, mechanically increases commercial bank reserves at the Fed, while leaving a shortage of treasury bills to park excess liquidity and lowering those rates to zero in the process.
The Fed has tried to mop up all that extra money through so-called overnight reverse repurchase transactions – and recently raised the interest rate on these to 0.05% to help keep it down. make. But the result was that daily volumes this week hit record highs of nearly $ 1 trillion.
Whether this is seen as a Fed tightening in and of itself or simply as a reflection of the magnitude of the money flowing through the system is a moot point. If the TGA decline slows after this month and Treasury bill sales increase instead, it could relieve all the pressure.
John Hardy of Saxo Bank points out that the problem has not changed the futures prices of future Fed key rate hikes per se. But he said it could “fuel the belief that the Fed will have no choice but to cut asset purchases as soon as possible.”
If so, a technical money market problem could have a more lasting impact on the dollar than initially thought.
But should we care if the dollar continues to rise?
Right now, it doesn’t seem like a stressful decision akin to the scramble for dollar funding around the world as the pandemic unfolded last year.
The surge in premiums on dollar funds at the time, reflected in so-called core currency swaps, has yet to resurface – in part thanks to swap channels between the world’s major central banks.
But for countries and banking systems indebted in dollars, rising US real rates and a higher dollar exchange rate can still be toxic by significantly tightening financial conditions – thus feeding demand for dollars into a dangerous loop.
While a higher dollar may be welcome in advanced economies in Europe and Japan, it is a financial tightening for emerging markets more dependent on foreign funds.
The Bank for International Settlements annual report cautioned again on this, adding that many emerging markets are running large budget deficits, external debt ratios have risen and credit ratings have deteriorated. .
“Historically, these vulnerabilities have coincided with greater investor withdrawals.”
by Mike Dolan, Twitter: @reutersMikeD; edited by David Evans