By Mike Dolan
LONDON (Reuters) – The U.S. dollar's latest surge has prompted central banks around the world to scramble, selling greenback reserves to stabilize local currencies but could adding the strength of the dollar into the bargain and the difficulties of laying down the line.
If hard currency reserves, usually banked in US debt, are run down significantly, it could just push Treasury yields higher at the margins and strengthen one of the key reasons for dollar strength in the process. Until Treasury yield tightening eventually forces foreign capital out of US “special” markets in general, the process could spiral from here.
The Federal Reserve's “hawkish cut” on Wednesday provided the latest spur to the greenback by prompting markets to rethink the rate horizon next year on suspicions that the Fed's new 4.38% policy rate may not be met back below 4% in the current cycle.
As US Treasury yields climbed on both that hawkish message and higher Fed inflation forecasts, the dollar went with them – spooking many major emerging markets that still rely on big dollar funding and fears of tariff hikes from Donald Trump's White House.
The Fed's own broad trading weight – up nearly 40% over the past decade – again holds the record highs set in 2022, with the index ” real” that is inflation-adjusted less than 2% from all-time highs as well.
The latest turn has been painful for many emerging economies in particular, with many dealing with both trade threats and domestic crises.
Brazil stands, where the real has lost more than 20% of its value this year and 12% of that in the past three months – hit by rising budget concerns even against central bank rate increase 100 points this month. .
The currency crisis has prompted the central bank to intervene in the open market and sell $5 billion in a second surprise auction on Thursday – the largest of its kind since the Brazilian currency went into effect in 1999.
The central bank has now held six spot interventions since last week, selling a total of $13.75 billion, as well as three dollar auctions with repurchase agreements of $7 billion.
But Brazil is far from alone.
Compounded by a recent government crisis, South Korea's winnings have fallen to their lowest level in 15 years, while India's rupee hit its lowest level and Indonesia's rupiah hit a four-month low.
All three central banks actively sold dollars on Thursday along with strong verbal warnings of further action.
China, which has the world's largest stash of hard currency and is the second-largest holder of Treasuries, is also suspected of selling dollars on Thursday to move the yuan's slide to 2024 lows.
According to JPMorgan, capital outflows from emerging economies excluding China were around $33 billion in October alone. Including China, it was $105 billion – the largest monthly outflow since June 2022 just before the US election.
While flows were steady just before this week's Fed meeting, it is clear that pressure is now back to the end of the year.
“We could be moving into a new equilibrium — one where market portfolio flows could be difficult,” JPM analyst Katherine Marney told clients.
QUEEN OF JEWS
But does it still matter to Treasuries if emerging market central banks pull back, with less demand for US debt or even an outright selloff of notes and bonds?
Together, entities from China, Brazil, South Korea and India account for approximately $1.5 trillion of overseas holdings of Treasury Securities.
That may seem small against the total of $28 trillion of outstanding marketable Financial securities. In addition, these levels may be flatter than in official holdings and dollars sold in intervention may not involve depreciating securities. debt per se.
But it seems that these countries are also not the only ones selling dollars into the new rally and the extent of any overall impact could affect the demand for finance at the margin at a sensitive time.
With US debt and fiscal concerns already high about the incoming Trump administration and the Fed, any additional stimulus to Treasury yields would not add to the pressure.
The more Treasury yields climb, the higher the dollar will go and perhaps the overall heat from the US markets will start to scare the rest of the world that is now invested in big there.
The big question next year may be the extent to which spiraling Treasury yields finally hit the expensive and crowded US stock market. That could weaken the huge flow abroad to the “exceptional” United States over the past decade and increase the value of the dollar.
That massive foreign demand for US securities and the massive performance in US stock prices and the dollar over recent years has pushed the US net international investment position (NIIP) to a deficit of $22.5 trillion by mid-2024, according to the latest figures.
That is now about 77% of GDP – twice what it was 10 years ago.
US liabilities increased by $1.4 trillion to a total of $58.52 trillion, mainly due to rising US stock prices that raised the value of portfolio investment and direct investment liabilities.
But about $391.1 billion of additional foreign purchases of U.S. stocks and long-term debt securities added to the liability increase.
Overall, portfolio investment liabilities increased $666 billion to $30.89 trillion and direct investment liabilities increased $568.2 billion to $16.64 trillion, mostly due to Wall Street gains.
All of that seems to have extended further since June.
The high level of the US dollar and Wall Street prices – and seemingly omnipresent about the outlook for 2025 – means that any disruption to capital flows and exchange rates at this point could turn the market dangerous and to a large scale without the intention of bringing it back on a large scale.
The views expressed here are those of the author, a columnist for Reuters.
(by Mike Dolan X: @reutersMikeD; Editing by Sam Holmes)
