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
