Along with the surge in bond market yields that gathered pace from mid-year,the OPEC+ cuts to production around that time that ignited oil prices might have been a factor in the dollar’s strength. The US dollar has risen more than 7 per cent on a trade-weighted basis since mid-July.
Interest rate differentials,the exodus of foreign investors from a slowing and more problematic China and slower global growth generally have seen capital flowing towards the traditional safe haven of the US treasuries market,also underpinning the dollar’s strength.
While the correlation between the dollar and oil might have remained quite tight until the past week,the inverse correlations with other commodities like gold and copper have been reflected in falls in their prices of 9 and 11 per cent respectively since July.
As with oil before the US achieved near self-sufficiency,dollar strength makes other commodities more expensive for non-US buyers and weakens activity and demand.
Also,US treasury bonds compete with gold as safe-haven assets. With bond yields spiking and the dollar strengthening – and the gold price falling away – they are more than competitive at present.
A strong dollar and high interest rates also impacts speculative activity. Over recent decades commodities have been increasingly financialised,with hedge funds and investment banks trading them,and derivatives based on the physical commodities,like any other financial asset.
The abruptness with which US bond yields have moved and the dollar has strengthened would be putting a lot of pressure on speculative trades and usually highly leveraged arbitrage activity and cross-border trades (“carry trades”) in particular,given the rate and degree to which other currencies have been impacted.
It will surprise no one if there are some significant hedge fund losses,or a big fund blows up,given the degree of volatility in financial markets and the pace at which financial conditions in the US have tightened and are continuing to tighten.
The plunges in the value of the Australian dollar since July,from around US69¢ to just over US63¢,and in Japan’s yen,from 138 yen to the dollar to 149 yen,are indicative of the degree to which the Fed’s aggressive monetary policy stance and the strengthening of the US dollar are disrupting other economies and exerting pressure on their policymakers to respond with decisions they might otherwise have preferred not to make.
The Bank of Japan may or may not have intervened (it’s saying nothing) on Wednesday to halt a freefall in the yen that was threatening to push the exchange rate above the 150 yen to the dollar level,but there is a point at which it,or the Reserve Bank,or their peers elsewhere,would step in to put a floor under their currencies either through interventions in markets,or through changes to their own monetary policies.
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The re-emergence of the inverse correlation between oil prices and the US dollar may be momentary.
If the slump in demand for petrol is signalling a US recession,then the Fed might retreat from its higher-for-longer conviction and bond yields,the dollar and oil prices would fall back. The markets will inevitably price in any shift in the Fed’s stance before it actually happens.
Unhappily for OPEC+,which includes Russia,if the production cuts which drove the oil price up to almost $US100 a barrel contribute to a US (and probably more global) recession,they will,because of their over-reliance on oil revenues,be impacted by the fallout as well.
Dollar dominance exposes the rest of the world to the conditions in America’s financial markets and economy,for good and bad.
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