Monday, June 13, 2016

New BIS Warning? - "Stronger US Dollar is Putting Strains on Global Financial Markets"

Last month we covered a speech by BIS Chief Economist Claudio Borio. Mr. Borio said there was "no doubt the dominance of one currency (the US dollar) creates challenges for the IMFS" (International Monetary and Financial System). He went on to say that what he felt was needed were "stronger anchors at the national and international level." You can read his full speech here.

This week we have a new speech by BIS Economic Adviser Hyun Song Shin. In this new speech we once again see concerns about the US dollar discussed. Below I have pasted in the extract of the speech and links to some news articles covering it. You can read the full speech here. This speech has a lot of information in it so I may do a followup article on it. I recommend reading the full speech.

Extract Summary of the Speech

"A stronger US dollar is putting strains on global financial markets and the banking system, leading to tensions not only in emerging market economies, but in "safe haven" currencies such as the Japanese yen and the Swiss franc. One intriguing development has been the breakdown of covered interest parity (CIP), which ensures that interest rates implicit in currency markets are consistent with those in money markets. CIP broke down during the financial crisis, and deviations have reappeared in the last 18 months, with the size of the deviations fluctuating in step with a stronger dollar. The breakdown reflects, in part, the tensions created by the divergence of monetary policy among major central banks and the withdrawal of easy dollar credit conditions that prevailed after the financial crisis, all in the context of the dollar's special role in the global financial system. As the dollar has strengthened, investors have found it harder to roll over hedges put in place when the US currency was depreciating and investors were borrowing more in dollars to take advantage of low interest rates. BIS data show that the euro and the yen may be starting to take on the features of an international funding currency, following in the footsteps of the dollar."

Reuters article on this speech  (some quotes below)

Distortions in dollar-based interest rate markets resulting from the U.S. currency's two-year rally pose a growing threat to financial stability, the Bank for International Settlements warned on Wednesday.

"Hyun Song Shin, head of research at the BIS, said a breakdown in what is known as covered interest parity and the resulting strains in cross-currency basis rates could have a negative impact across the global financial system.

The Swiss-based BIS acts as a forum for major central banks.

"In spite of the outward tranquility, there are tensions beneath the surface," Shin told a World Bank conference in Washington.

"The financial tail appears to be wagging the real economy dog. This is not how things are supposed to work. The key takeaway is that a stronger dollar is associated with more severe market anomalies," Shin said."                      . . . . . .
"Shin's comments on Wednesday follow similar warnings a month ago from his BIS colleague Claudio Borio that the dollar's overwhelming position of dominance in the global financial system posed risks to world financial stability." article on this speech (some quotes below)

"Financial markets have become the tail "wagging the real economy dog", as American monetary policy and a strong US dollar strain the global financial system, according to the Bank for International Settlements.

In a development that has shocked policymakers, mounting financial pressures are extending beyond well known risks in emerging market economies to safe haven currencies such as the Japanese yen and Swiss franc.

BIS economic adviser Hyun Song Shin said the world economy was dancing to the "tune of global financial developments".                         

. . . . . .

"The pre-eminent role of the US dollar as the global funding currency means that US monetary policy has an especially important place in the determination of global financial conditions," the BIS said."

Read the full article here

(note: I added the underlines above & below for emphasis of some key points)
My added comments: Because the news articles covering this speech clearly view this speech as a warning on systemic risks posed by a strong US dollar, I will add this to our list of IMF and BIS warnings page

Note the statement in the second article attributed to the BIS above that says "American monetary policy and a strong US dollar strain the global financial system." Also note the comment that "US monetary policy has an especially important place in the determination of global financial conditions." This sounds as if it is directed at the US Fed.

If US dollar strength is viewed as a risk to the global financial system, it seems unlikely the US Fed would raise interest rates into the face of such a perception since that would tend to further increase dollar strength which the BIS says is "putting strains on global financial markets and the banking system."

Added note 6-15-16 (2 pm): As we might have expected, the Fed annouces they will not be raising interest rates and even suggested they might do fewer increases in the future than previously expected. Janet Yellen noted that international uncertainties loom large which suggests they are paying attention to comments like the one above from BIS and others. The Fed has more peer pressure not to raise rates from what I can see at this point in time.

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