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:
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.