One Bank’s “Doomsday, Nightmare Scenario”

One of the most critical market trends that gets virtually zero attention in the mainstream financial media is the worsening global dollar shortage.

This finds ready expression in wide G4 cross-currency bases:

bases

(Deutsche Bank)

This is a topic I’ve spent considerable time discussing over the past year or so. The cost of obtaining dollar liquidity probably shouldn’t be that high. Indeed, the fact that xccy bases were essentially zero pre-crisis strongly suggests that something, somewhere is broken.

As you might have guessed, the post-crisis regulatory regime and the ebb and flow of global central bank policies are primarily to blame (think the cost of balance sheet for banks and rate differentials, respectively).

If the “relentless demand” (as Deutsche Bank puts it) for dollar funding doesn’t abate (and there’s every reason to believe it won’t), and if the repatriation of dollars under a Trump tax holiday and a reduction of imports from Asian economies conspire to suck still more dollar liquidity out of the system forcing an even heavier reliance on FX market USD borrowing, one wonders if we might end up in crisis mode.

Below is how Deutsche Bank sees such a crisis unfolding (note that this isn’t their base case scenario and if it was they certainly wouldn’t admit it).

Via Deutsche Bank

It is easy enough to concoct doomsday scenarios that might arise out of the imbalances and stresses that we’ve documented. We can, for example imagine a scenario where a crisis erupts in the US and dollar funding simply evaporates. The banks have no balance sheet capacity to meet demand. Cash in money market funds that might have been available under the previous regulatory regime is tied up in short-term government securities. To compound the nightmare, there is a flight to quality away from US and US Treasury prices collapse, so even the super safe government money market funds could be at risk of “breaking the buck”, leading to an unexpected run as investors try to withdraw their funds. The only game in town is the central banks. Would they be able to respond fast enough before a wave of defaults sweeps through financial sector? For that to happen they might have to open their doors to all comers, which might be all but impossible given this is hardly standard operating procedure.

 

 

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5 thoughts on “One Bank’s “Doomsday, Nightmare Scenario”

    • From Deutsche..

      “The Fed has stated it will
      make dollar swaps available. The ECB has reportedly obtained dollars through
      this channel but so far is charging a premium that makes this an unattractive
      option. Or, central banks with major dollar reserves (such as the BOJ or PBOC)
      could make them available through xccy swaps. So far there has been little sign of
      this happening, whether because of a perceived stigma associated with dealing
      with central banks, or because non-US central banks are wary of putting upward
      pressure on their currencies. Bottom line: major central banks are contributing
      to if not outright driving the stresses in the xccy basis market, but doing nothing
      to sterilise that impact. At this point, we do not expect central banks to provide
      much relief to the xccy swap market unless there is a major crisis.”

  1. http://seekingalpha.com/article/4040076-coming-depression-economics?app=1&auth_param=15ucug:1c8mfs5:036b78d40374a70c3b5a748c22350a89&uprof=45&dr=1

    This guy has been cataloging the dollar shortage since 2008. He has continually proven that the people responsible are the same ones that you admire. That what you decry as “fake news” is actually the only real news there is. So once again, you are either factually ignorant (may or may not be your fault depending on how early in life you were indoctrinated) or a paid lackey. So which is it?

  2. I learned from experience that the optimal dose of skepticism is usually “a sh*t load more than most people harbor, but a whole lot less than someone wearing a tinfoil hat.”

    The more susceptible you are to vast, sweeping conspiracy theories, the more susceptible you are to being taken advantage of by people who come to realize that that’s your predisposition. Sometimes, they take advantage of you by printing ridiculous stories that they call “alternative news” and profiting from your clicks. But other times, they’re looking for your vote. When the click profiteers and the vote seekers get together, you get Donald Trump as President and Steve Bannon as a White House adviser. The next thing you know, CNN calls bullsh*t and you’re told that there’s such a thing as “alternative facts.” A handy rule of thumb: if someone has to use the word “alternative” or its shortened “alt” to legitimize their content, it probably means that whatever they’re saying is suspect.

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