Dollar ‘disruptions’ could rattle global financial system
A fragile dollar could wreak havoc on the global financial system unless US authorities intervene and provide a backstop, a new report has suggested.
President Donald Trump’s full-blown trade war with China has sent markets around the world sliding while the dollar index on Thursday afternoon was 8.7 per cent below levels seen three months before.
Now, a new report by S&P Global Ratings has warned that friction between the world’s most powerful economy and its trading partners could lead to a damaging shake-up of the global financial system.
Central banks often rely on swap lines, otherwise agreements made to exchange currencies to boost liquidity levels in moments of crisis.
A breakdown in central banks’ relations with the Federal Reserve, whose dollar reserves are seen as crucial for stability in global financial systems, could leave economies exposed, according to analysts at S&P Global.
“The globalisation of the financial market was underpinned by a high degree of global coordination on financial regulation, with the Basel accords a key mechanism to achieve global alignment, and on financial stability management, with the Federal Reserve’s US dollar swap lines playing a central role in times of crisis.”
The report’s authors said they believed a breakdown in relations remained a “remote possibility”.
But they also said that hundreds of financial businesses dependent on external dollar funding would be “most exposed” to tightened funding. Hedge funds have have deleveraged their assets while Treasury yields have spiked rapidly.
Banks may also question whether the Fed would be open to providing a global backstop in any crisis under the Trump administration, S&P Global analysts said, as the global financial system depends on the economic giant to provide support and stability.
“Given the prominent of the US dollar in the global financial system, this minimum level of coordination is hardly conceivable without a commitment from US authorities to contribute to global financial stability, for instance by providing a backstop to global needs for US dollar-denominated liquidity in the form of central bank swap lines, in case of stress.”
Japan was cited as particularly vulnerable to disruptions in dollar markets given its high exposure to the US. The Bank of Japan is telling its banks not to expect backstops from the Fed.
“Short-term or bank-specific difficulties in foreign currency funding could damage the creditworthiness of affected banks,” the report said.
Trump’s unpredictability has left major banks worried about his possible interference with the Fed, which is independent from the White House’s executive order.
The US President attacked Fed chair Jerome Powell again today as he called on the central bank to lower interest rates. Powell’s term is set to end in May but Trump said “termination cannot come fast enough”.
The ongoing trade war could also yet worsen and put the dollar under greater strain.
Extra 10 per cent tariffs on goods arriving from major economies and even uninhabited islands also loom as Trump gave countries which did not initially retaliate a 90-day reprieve.
The S&P Global report said the likes of France and the Netherlands could be affected by a deterioration in relations as banks rely on dollar and euro swaps to fund their exposures.