Dollar may be set for new damaging bout of strength

LONDON: If the 2008 financial crisis is any guide, world markets – which have barely had time to recover from the dollar’s 9% surge in mid-March – may be set for another damaging bout of strength in the greenback.

In the 10 days from March 9, the dollar leapt against almost every other currency as companies and banks bought it to pay their creditors, trade partners and suppliers. Money market funding rates jumped and share prices plunged as those desperate for the US currency liquidated investments.

Such a spike in the dollar – the currency of choice in global commerce and investment, used in up to 90% of all foreign exchange transactions – is bad news, as it rapidly tightens financial conditions, exacerbating the very problems that policymakers are striving to prevent.

Since March 23, the surge has faded, as the US Federal Reserve cut interest rates again, injected trillions of dollars into the financial system and opened swap lines with other central banks to ease dollar strains overseas. Currency swap rates have calmed down and equities are rallying again.

But what if this is just a pause rather than a halt to the dollar’s upward path?

Brown Brothers Harriman strategist Ilan Solot, who worked at the Fed in 2008 as a currency trader, is among those expecting another bout of dollar strength. “Policymakers understand the funding shortage problem well from the previous crisis and they have rushed to solve that, but this crisis could very well see a real economy shock.”

Central bankers have repeated the stimulus playbook of 2008, but “this is a liquidity shock to the real economy, and we don’t know how that will play out,” Solot added.

Like many analysts, he suggests looking at the 2008 crisis.

Through all of 2007 and well into 2008, the dollar index fell steadily as hedge funds ramped up short positions despite growing unease over US subprime mortgages and the collapse of Bear Sterns. But from March to November 2008, the dollar rocketed 24% thanks to overseas demand.

And much like recently, money market rates soared.

Then Fed rate cuts and Washington’s US$700 billion (RM3.03 trillion) bank bailout bill kicked in; as the money market logjam eased, the dollar retreated and troughed on Dec 18, 2008. The respite was brief, however. The currency took off again, and rose another 15% before peaking in March 2009. That allowed equities and emerging markets to bottom out.

The uncertainty this time is that the twin demand and supply shocks caused by the virus could last indefinitely. Companies and individuals trying to stay afloat are likely to hoard cash dollars. – Reuters