Dollar dependence sets markets for ‘liquidity crunch’

The current run-up in US Treasury yields and the dollar poses a major stress test for a global financial system that has become even more dependent on the American currency since the last credit conflagration.

Mehul Daya and Neels Heyneke, strategists at South Africa’s Nedbank Group who have analysed the role of the greenback’s liquidity in past crises, argued that “a stronger US dollar and the global cost of capital rising is the perfect cocktail, in our opinion, for a liquidity crunch” in a note Thursday.

A key feature of the global financial crisis a decade ago was a chronic shortage of dollars that eventually spurred the Federal Reserve to set up swap lines with more than a dozen central banks to ease funding pressures. Yet the world has doubled down since then: dollar credit to borrowers outside the US — excluding banks — climbed to 14% of global gross domestic product by March, from 9.5% at the end of 2007, according to estimates cited in a Bank for International Settlements paper.

With dollar yields climbing alongside an appreciation in the greenback itself, that’s set to pose a stress test for those without dollar revenue. Benchmark 10-year Treasury yields climbed to 3.23% Friday, the highest since 2011. And the Bloomberg Dollar Spot Index has advanced 5.6% in the past six months.

Growth of credit in dollars has outpaced that of other foreign currencies in all major emerging-market regions, BIS economists Inaki Aldasoro and Torsten Ehlers wrote in a paper last month. That’s a danger given that “international bond investors tend to retreat quickly when US rates rise,” they wrote. An appreciating dollar also “increases tail risks” for fund managers holding emerging-market assets, they said.

For their part, Daya and Heyneke concluded in a separate note last month that “as the global economy and financial system have become more systemically leveraged, their sensitivity to changes in the cost of global capital has increased; hence, we believe the next downturn may be more serious than previous ones.”

� L.P