(Following press release was provided by the Bank for International Settlements)
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, BIS Economic Adviser and Head of Research Hyun Song Shin said on Wednesday.
Speaking at a World Bank conference in Washington DC, Mr Shin said market strains were visible not only in emerging economies but in advanced economy currency markets. One intriguing development has been the breakdown of a rule which has traditionally been seen as a yardstick for well functioning markets. The relationship, known as covered interest parity, ensures that interest rates implicit in currency markets are consistent with those in money markets. That relationship broke down during the stresses of the financial crisis, and deviations have reappeared in the last 18 months as the dollar has strengthened. The size of the deviations has fluctuated in step with a stronger dollar.
“The key takeaway is that a stronger dollar is associated with more severe market anomalies,” Mr Shin said at the World Bank’s “The State of Economics, The State of the World” conference.
“The amazing thing is that this is true not only for emerging markets, but also for ‘safe haven’ currencies such as the yen and Swiss franc.”
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 it place when the US currency was depreciating and investors were borrowing more in dollars to take advantage of low interest rates. BIS global liquidity indicators show that non-bank borrowers outside the United States owed $9.7 trillion; a third of that, or $3.3 trillion, was owed by borrowers in emerging markets.
BIS data show that the euro and the yen may be starting to follow in the footsteps of the dollar: lending in those currencies outside the currency areas has increased as they have depreciated.
“As the euro and yen join the dollar in the ranks of international funding currencies, we are left with a dilemma. With each successive wave of monetary easing after the financial crisis, greater demands are being made on international capital markets,” Mr Shin said.
Shin's speech, "Global liquidity and procyclicality," is available at www.bis.org