The Persistent Global Ripples

by: Alhambra Investment Partners

By Jeffrey P. Snider

Though we have passed through the event horizon on the taper finally, it is still difficult to understate how much the threat of it upset the various settled mannerisms of credit and dollar markets this past summer. Though there is a degree of calm in appearance now, there are certainly more than a few hints of markets still enthralled by some degree of turmoil.

Emerging markets seem to be where this roiling undercurrent is most visible. From Turkey to Thailand, currencies are straining under dollar pressure. And we need not mistake that as a cause, either. It is pretty conclusive from all the evidence and anecdotal coincidences that dollar trading and tightening bears most proximate responsibility.

Take the case of Brazil, as the Banco do Brasilia "surprised" markets by raising the benchmark repo rate (SELIC) by 50 basis points instead of only 25. The impetus was just as clear, as devaluation set apace by dollar tightening has pushed inflation well above any targets or even toleration. This despite the first contraction in GDP since 2009 (any Keynesians are welcome to explain that supposed "contradiction").

December's surge in Brazilian prices, which the mainstream is blaming for the surprise level of tightening, occurred just as the real wound its way back toward the crisis peak of 2.40 to the dollar. The move in the currency against the dollar was supposed to have wrested from fleeing investors by Brazilian swaps. The central bank had promised to promise (essentially what the Brazilian swap system amounts to) using its own dollars, immediately congratulating itself on its bravery. Fooling banks into importing dollars through leverage is not usually a long-term solution.

That appears to be a theme that is much wider afield than just the Eastern half of South America. From the latest TIC data, we see that there is a very clear dollar issue that has persisted beyond the massive dollar warning from June. In other words, like the US and eurodollar markets, the aftershocks and reverberations in dollar-land are still being felt.

Monthly net selling of US dollar holdings by foreigners is a rarity, as the chart above shows. June 2013 saw the largest dollar liquidity drive in the series history, but that did not portend the end of the apparent difficulties at all. Narrowing the gaze into overall US dollar assets held by foreign central banks (official), we see that for the first time since 2009 there has been a cumulative selling episode, even now almost six months past that warning.

We can narrow that further into just foreign central bank holdings of US treasuries where we see what it is these central banks are using to obtain off-market, non-financial dollars. If banks are unable or unwilling to supply them in eurodollars, central banks are both issuing swaps (in lieu of selling dollar holdings, since outright selling is the kiss of death for a weak currency) and using reserve assets in limited amounts (for now).

The amount of selling now is actually more acute than during the waves of dollar crisis in 2007-08. I think that is a bit of a tortured comparison, however, since emerging markets were not as central to that crisis as Europe and London. This time around, the locations have moved and so have the mechanisms of dysfunction. There is much closer working and operational relationships between the Fed and the ECB, Bank of Japan, Bank of England and Swiss National Bank than with emerging markets. That is particularly true in that banks in those countries often are exclusive to eurodollars.

In terms of the taper-driven tightening, specific country data shows that every major holder of dollars were forced to liquidate to some degree; that included China and Japan.

I am very tempted to use this data as evidence that the dollar crisis is causative toward the yuan tightening (SHIBOR spiking to record highs) in China during June, but it's not conclusive as such. There is little doubt that there are strong connections between dollar liquidity globally and local Chinese bank funding, though.

Of the smaller holders, we see Brazil as a net seller of only about $9 billion in US treasuries, but that does not fully account for the usual rise in reserve balances that would have occurred absent the dollar tightening. But even given that, it is only a minor decline which is to be expected given that the Banco has chosen the swaps route (again, for now).

What is much more surprising is that the "oil exporting" nations have been some of the largest net sellers, implying that those countries might be in need of dollars the most. The selling of treasuries is likely completely set apart from the reduction in US imports of petroleum since that would only infer a dimishment in the rate of purchase rather than outright sales.

There are still dollar problems that are rippling through the global finance system even if US investors are wistfully unaware or intentionally dismissive. The Fed may have finally tapered, but it was the mere suggestion that began the chain reaction. Now that it has been set in motion, there may not be much to be done but let it run its course, which it will inside and out.