A surging US dollar signals for some the clearest sign of an ebbing money tide and an abrupt slowdown of the world economy over the remainder of 2021 at least.
Disruptions from new strains of Covid-19, severe goods and labour supply bottlenecks, fuel price squeezes, power outages, slowing credit growth and the gradual withdrawal of central bank liquidity have drained the post-pandemic recovery of momentum.
Global economic data surprises all turned negative in August and continue to miss forecasts at a rate not seen since 2020, prompting some banks to cut growth forecasts.
Although these have been modest so far, HSBC last Thursday downgraded global gross domestic product (GDP) forecasts for this year and next, seeing growth almost halving to as low as 3% by 2023.
Aggregate bond borrowing rates have backed up from historic lows, reclaiming about half the drop from pre-shock levels. And world stocks have recorded their first negative quarter since the first three months of 2020, when Covid-19 first hit.
The dollar, however, is gaining across the board, up almost 5% against major world currencies since June and hitting its highest 2021 levels against the euro, yen and sterling.
Such dollar surges are often both a reflector and amplifier of financial stress and have a habit of snowballing.
Consensus polling from the start of the year or even a month ago says this was not meant to be, with median forecasts for a steady weakening persisting until August.
And yet analysts convinced that global credit growth and liquidity are the dominant drivers of all asset prices – notably Citi’s Matt King and Michael Howell’s CrossBorder Capital – have been raising the alarm since early summer.
As many major central banks step back from emergency pandemic settings and China’s credit impulse slows, global liquidity growth has fallen and stock markets retreated.
King’s note last week stressed again that quantitative easing (QE) continues to diminish and private credit growth is faltering, adding “low real yields are now the last factor propping up markets.”
If true, “real”, inflation-adjusted, yields are now twitching back into life as markets map not just an horizon for a reduction of bond buying but for interest rate hikes too.
Crucially for the dollar, US real rate rises have outstripped the rest since September’s relatively hawkish Fed meeting – and keeping longer-term market inflation expectations that risked undermining the greenback under wraps.
CrossBorder Capital put the dollar jump in the mixer.
In a note entitled “Bad News is Closer Than You Think”, it said ebbing liquidity growth is already slowing the world and any further sharp squeeze due to nerves about monthly inflation prints could well sow instability and risk another recession.
“This episode has all the ring of a major policy error,” it said, adding that recent gains in the dollar and flattening of the US Treasury’s five year-10 year yield curve in inflation-protected securities were a decent guide to monetary conditions and show how markets are pricing gradual tightening ahead. If central banks get any more aggressive, these market moves would get supercharged.
Another dimension is China’s slowdown, its policy orientation to “stability” over “growth”, worrisome property sector and local government debts and its jarring of investor nerves amid serial regulatory crackdowns.
“The West now faces two tricky adjustments at once: the end of the QE and the end of the Chinese credit boom,” CrossBorder concluded. “Global liquidity looks set to tumble.”
A combination of rising US real rate premia and a preference for dollar cash in a stressed financial environment could well push it much higher into year-end as the Fed prepares to execute the first tapering of its bond-buying spree.
That combination of rising real rates and a rising dollar is toxic for non-US borrowers who have loaded up on dollar debts – huge chunks of which were incurred after the pandemic hit and many of which need to get refinanced over the coming two years.
That negative feedback loop causes its own stress.
Recent studies spotlight the surge in dollar borrowing last year by non-banks outside the United States after a brief initial credit crunch.
Bank for International Settlements data showed the total of dollar credit to these entities had already topped US$12 trillion (RM50.2 trillion) by the middle of 2020 – more than 14% of world GDP, compared to less than 10% in 2007.
Perhaps ominously, the Institute for International Finance points out that about half a trillion dollars of the more than US$4 trillion (RM16.7 trillion) of emerging market bonds and loans coming due next year is denominated in dollars.
And if stress begets stress, policymakers may do well consider the dollar’s role in it once again.
Their silence on nascent foreign exchange movements during separate meetings of G4 central bankers and G7 finance ministers this week showed it’s still low down their priority list. A more turbulent fourth quarter may change that.