Heisenberg Nightcap (Dollar Edition)

I’ve written volumes lately about the soaring dollar and the worsening global USD funding shortage .

On the heels of Donald Trump’s election, the broad dollar has soared to a 14-year high. This comes just nine months after the so-called “Shanghai Accord”, a tacit agreement between the world’s foremost monetary authorities who decided in February that a weaker dollar (at least in the short-term) would help markets find their footing after renewed deflation fears and China jitters combined to throw investors for a loop in January.

The Fed subsequently leaned dovish in March, the dollar softened a bit allowing for a more orderly devaluation of the RMB, and before long, things had calmed down considerably.

Well as summer turned to fall, the greenback began to gain some momentum. Then we got Trump. And a sharp repricing of yields. And a more hawkish outlook from the Fed. Now here we sit:

Here’s what Goldman had to say late last month:

Our longstanding view has been that divergence in the activity and inflation outlook would drive rate differentials in favor of the Dollar, and that the focus would shift away from ECB and BoJ easing to Fed tightening. The US Presidential elections have finally moved the needle in this direction, representing a “reset” for the USD, and the divergence theme is back in play. US front-end interest rates have moved up, but the market in our view is still catching up to the changed landscape and is pricing too little tightening through end-2019, which points to further upside for the Dollar. We expect the USD to continue to move higher and we forecast the TWI USD to appreciate about 7% versus G10 currencies over the next 12 months.

At this juncture there are more questions than answers, not the the least of which is this: how long will it be before structural dollar strength triggers a veritable EM meltdown?

With that in mind I bring you the following chart from Morgan Stanley which “provides a ranking of highly indebted countries which may be hit by a combination of higher USD funding costs and a higher USD.”

(Chart: Morgan Stanley)

Don’t forget, the Fed admitted in September of 2015 that its reaction function now explicitly includes global financial conditions. That means that going forward, EM tremors (and we can include in that yuan worries stemming from a rising dollar) will be just as good an excuse as any to think twice before pulling the rate hike trigger.