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Dollar Liquidity Dynamics: An Epochal Shift Is Coming, One Bank Warns

"In this environment the infamous carry-trade will come under pressure and the misallocation of credit will be revealed."

Dollar liquidity (or a prospective lack thereof) is an important theme in 2018 as the Fed proceeds apace with gradual rate hikes and the policy divergence between the U.S. and the rest of the world widens in favor of the greenback. One of the more interesting dynamics in the back half of 2017 and for the first couple of months in the new year, was the extent to which the dollar stubbornly refused to respond to a USD-bullish trend in the UST-bund spread. Dollar weakness was generally attributed to two things: the idea that U.S. trade policy telegraphed the Trump administration's desire for a weaker currency and worries about a deterioration in the U.S. fiscal position. Finally, starting in late April, the greenback began to climb with a continued widening in the spread between U.S. and German yields. The first quarter of 2018 was defined by a technical dollar funding squeeze and a liquidity drain catalyzed by three key drivers (this is Goldman's list, but there's a general consensus on this across markets): The change to the tax treatment of foreign earnings from US companies; Changes to the Base Erosion and Anti-Abuse tax (i.e., BEAT); The surge in T-bill issuance
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2 comments on “Dollar Liquidity Dynamics: An Epochal Shift Is Coming, One Bank Warns

  1. Error404 says:

    “[As an aside, those policies are introducing myriad longer-term tail risks, not the least of which is this: when the next downturn finally materializes, any Fed rate cuts will come against a backdrop of a deteriorating U.S. fiscal position, raising questions about who’s going to be willing to sponsor the U.S. long end and setting the stage for a crisis of confidence in the dollar].”

    Fair enough, and a good question. Two thoughts:

    Much will depend on timing. If Eurozone sovereigns lose sponsorship before USTs lose it – a very real possibility given the ECB’s stated schedule and the rapidly evolving debacle that is Europe – then the now rather tired ‘cleanest dirty shirt’ cliche might come into play.
    QE will most probably reappear if/when the next downturn gets scary, so the Fed – again – might be part of the the answer to your question.

    As an aside, donning my tin-foil hat helps see a surprising number of significant actors who could ‘use’ a crisis: the Wall Street wing of the Dems to prove that Trumponomics doesn’t work after all, the ECB so it has cover not to wind down QE, and the US to get the Fed bid back in the market as an alternative to losing control of the long end and risking blowing the system apart. Again.

  2. Barnes says:

    One of your best blogs I’ve read. Very well put together and explains the complexity of what’s going on in simple terms. Thanks for all the work. I can only imagine the time put into research to gather these various sources and pull together a cohesive story.

    One question I’d have is whether those with USD debt see the same thing – and if they do would they not be converting it as quickly as possible?

    Also, a strong USD could greatly effect US exports, and exports are incredibly important for both growth and for trade. I am assuming some have done the math on estimating trade deficits based on various levels of the USD – assuming the big banks have and the CBO and the Fed. Of course assumptions would be difficult in this current environment of trade!

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