US$10 trillion a day global currency market becomes more volatile

The dollar, the world's No.1 reserve currency, is having a rocky ride as unpredictable White House policy moves and Federal Reserve independence concerns revive "Sell America" trades. While it is expected to weaken further, sudden rebounds in the greenback can catch traders out just as much as sudden sharp falls.

Having fallen almost 2% in one week in January to four-year lows, an index measuring the dollar's value against other major currencies then bounced back, causing metals market mayhem.

Here's a look at how dollar risks are rippling through world markets.

The dollar's rebound in the last two trading sessions, following US President Donald Trump's decision to nominate former Federal Reserve governor Kevin Warsh to replace outgoing Fed chief Jerome Powell has sparked a metals market meltdown.

Gold, which had notched up its best month in more than half a century in January, slumped 5% on Monday after its biggest daily fall since the early 1980s in the prior session - it regained some ground on Tuesday.

Traders had crowded into a popular currency debasement trade that relied on metals prices rising as Fed independence kept the dollar on a steady weakening path. That concept then dropped out of metals markets "at lightning speed," days, Societe Generale said in a client note.

US$10 trillion a day global currency market becomes more volatile.

A gauge of the most actively traded currency pair -- the euro/dollar exchange rate that measures expected volatility in three months' time, hit its highest since July last week.

According to Capital Economics, the dollar had become detached from traditional valuation metrics like the gap between US and Japanese or European interest rates.

Barclays has calculated a US policy risk premium for the dollar, meaning it is influenced by White House rhetoric and has become partly detached from the economic and growth forecasts that investors usually track. That could make stocks and bonds priced in dollars harder for foreign investors to hold and value.

While the indexes were lifted by gains in chipmakers, small caps also performed well, with the Russell 2000 jumping about 1%.

"The main question is whether people lose confidence in the US asset base," said Barclays global head of FX and EM macro strategy Themos Fiotakis.

Foreign investors own almost US$70 trillion worth of US assets, more than doubling their holdings in the last decade as Wall Street stocks boomed. European money managers are assessing their exposures.

A weaker dollar can boost US stocks by increasing the local currency value of companies' overseas earnings and often raises prices of Treasuries.

"But disorderly dollar decline could change this relationship," Bank of America analysts said in a note.

A disorderly drop would be a 5% monthly loss, BofA said, which could generate a "drastic sell-off of long-dated Treasuries," and tighten US financial conditions significantly.

A wider debasement trade, with the dollar falling in tandem with domestic assets, was also a risk, BofA said.

Courtesy: Reuters