Central Banker Observes Sudden "Evaporation" Of Dollar Funding, Warns Of Global Turmoil

Last October, just as the Fed started shrinking its balance sheet, we published yet another article on what is arguably the biggest threat to not only risk assets, but also the global economy: "The Dollar Funding Shortage: It Never Went Away And It's Starting To Get Worse Again."

While hardly a novel problem, we first discussed the return of the dollar funding shortage in March 2015, the fact that global stocks kept rising, and that overall funding conditions remained relatively loose keeping the global economy well-lubricated, prevented said dollar funding shortage from becoming a major concern to policymakers, despite occasional recent hiccups such as the Libor-OIS spread blow out, which both we and Citi explained w as a symptom of the creeping shortage of the world's reserve currency.

Until now.

In an op-ed published overnight in the FT, a central banker writes that when it comes to the turmoil gripping the world's Emerging Markets, whether it is the acute, idiosyncratic version observed in Argentina and Turkey, which according to JPM may be doomed...

... or the more gradual selloffs observed in places like Indonesia, Malaysia, Brazil, Mexico and India, don't blame the Fed's rate hike cycle. Instead blame the "double whammy" of the Fed's shrinking balance sheet coupled with the dollar draining surge in debt issuance by the US Treasury.

That's the message from the current Reserve Bank of India, Urjit Patel, who writes that "unlike previous turbulence, this episode cannot be attributed to the US Federal Reserve’s moves on interest rates, which have been rising steadily since December 2016 in a calibrated manner." But does that mean that the Fed is not to blame for what increasingly looks like another budding EM crisis? Not at all: according to Patel, the dollar funding shortage "upheaval" stems from what he sees as the confluence of two significant events of which the Fed’s balance sheet reduction is one, while the second is the dramatic increase in US Treasury issuance to pay for Trump's tax cuts; what is notable is that both events are drastically soaking up dollar liquidity.

Urjit Patel, governor of the Reserve Bank of India

As a result, Patel blames a lack a coordination between the Fed and Treasury on the adverse flow through across global funding markets as a result of this decline in dollar liquidity, and writes that "given the rapid rise in the size of the US deficit, the Fed must respond by slowing plans to shrink its balance sheet. If it does not, Treasuries will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable."

Putting these two parallel processes - which threaten to materially impair dollar funding markets - in context, on one hand there is the so called "Quantitative Tightening", or the gradual decline in the Fed's balance sheet which is set to peak at a rate of $50BN/month by October, while at the same time US net Treasury issuance is set to jump to $1.2 trillion in 2018 and 2019 to cover the forecasted budget deficit of $804BN and $981BN in 2018 and 2019, respectively.

And visually:

And in a curious coincidence, the withdrawal of dollar funding by the Fed in monthly terms, as it reduces its reinvestment of income received, is proceeding at roughly the same pace as that of net issuance of debt by the US government. Furthermore, both processes are open ended which means that over the next few years, the government’s net issuance will stabilize, albeit at a high level, whereas the Fed’s balance-sheet reduction will keep rising.

Both are terrible news for Emerging Markets, which are in desperate need of reversing the ongoing dollar outflows; however as long as Trump continues to make America great, and funds said stimulus with excess debt issuance, emerging market turmoil is virtually guaranteed.

As Patel further explains, this unintended coincidence has proved to be a “double whammy” for global markets, and especially emerging markets, largely as a consequence of one key event: the evaporation of dollar funding, not only from sovereign debt markets but in short-term funding markets as well as the recent spike in the Libor-OIS spread showed.

This has manifested in a sharp reversal of foreign capital flows out of Emerging Markets over the past six weeks, often exceeding $5bn a week, resulting in a sharp drop in emerging market bonds, stocks and currencies.

And here, for the first time this tightening cycle, a prominent foreign central banker has accused the Fed of stirring trouble for emerging markets, with its ongoing tightening, and specifically, the balance sheet reduction coupled with the Treasury debt issuance surge, to wit:

Global spillovers did not manifest themselves until October of last year. But they have been playing out vividly since the Fed started shrinking its balance sheet. This is because the Fed has not adjusted to, or even explicitly recognised, the previously unexpected rise in US government debt issuance. It must now do so.

Patel's advice? Immediately taper the tapering, or rather, the Fed should "recalibrate its normalisation plan, adjusting for the impact of the deficit. A rough rule of thumb would be to reduce the pace of its balance-sheet contraction by enough to damp significantly, if not fully offset, the shortage of dollar liquidity caused by higher US government borrowing."

Incidentally, the various pathways described by Patel were conveniently laid out by Deutsche Bank's Aleksandar Kocic two weeks ago, and which we explained in "Why The Soaring Dollar Will Lead To An "Explosive" Market Repricing."

Of course, the Fed has a choice: it can simply ignore the ongoing crisis it is causing for Emerging Markets - after all the Nasdaq just hit a new all time high - but in that case Powell risks a broader contagion, first in EMs and then everywhere else. Instead, reducing the pace of balance sheet reduction...

would help smooth the impact on emerging markets and limit effects on global growth through the supply chains that span both developed and emerging economies. Otherwise, the possibility will increase of a “sudden stop” for the global economic recovery.

Patel's punchline: if left unchecked, the EM turmoil "might hurt the US economy as well. Circumstances have changed. So should Fed policy. It would still reach the same destination, but with less turmoil along the way."

The irony: one look at the Fed's balance sheet shows that it has barely declined, and already reputable foreign central bankers are demanding the Fed stop the pain.

One can only imagine the chaos and turmoil in EMs (and then DMs) in four months time, when not only the peak of the Fed's monthly shrinkage hits some time in October, but when for the first time since the financial crisis, global central bank liquidity will shift from a net injection to a net drain and then accelerate as both the ECB and BOJ proceed to taper their own Fed monetization.



zibrus Lordflin Mon, 06/04/2018 - 19:50 Permalink



Quick shout out to H_H, the better-half (and 2,3). Thanks again for putting together the 'real' fight club. It was great meeting everyone, the festivities were great (hopefully despite my revelry). Every speaker was wonderful and I came away with new knowledge on each field discussed. The personal stories were what I enjoyed the most. Speaking in front of a fighting/questioning crowd was actually very refreshing for me and I'd do it all again in a heartbeat. Also, the soap box at the end is a wonderful design characteristic (a mini fightclub) and it's wonderful hearing everyone's perspective. Hanging out afterwards was also a blast. I'm looking forward to the future with ya'll.




Edit: P.S.: I'll work on my two step.

In reply to by Lordflin

Haus-Targaryen Adolfsteinbergovitch Tue, 06/05/2018 - 03:05 Permalink

What Patel says makes sense. 

However he runs under the same assumption so many of us have run on for the past decade, and done so to our detriment. 

He still keeps using this word "market" but as the central bankers have shown us over and over again ... they will break any law, bluff and lie, jawbone and deceive yo keep their system going. 

Does India need us $1 trillion stat or they blow up the world? The fed will, behind closed doors print it and wire it to them. 

Crisis averted, everything is fixed. 

No my friends, until a big actor repudiates their debt publically so it's out in the open -- this keeps going. 

In reply to by Adolfsteinbergovitch

Unreliable Narrator Haus-Targaryen Tue, 06/05/2018 - 12:24 Permalink

Viva la Triffin Dilemma.

As long as the dollar is the world reserve currency, the dollar supply must increase by the growth of the US + growth of other nations, financed by the US taxpayers and consumers.

Reserve status isn't a benefit.  It's the biggest financial ass-reaming ever invented.


First stop on the road to debt reduction is elimination of the reserve status of the dollar, and the only way that happens is to make dollar dependency by the EM freeloaders painful enough that they negotiate payment in alternate currencies.


Let the yuan take over.  See how Xi likes running deficits.

In reply to by Haus-Targaryen

ilion bobcatz Tue, 06/05/2018 - 03:27 Permalink

Some segments of the financial industry are enjoying increased business due to huge volatility that we have experienced in 2018 during the first 5 months. Tickmill, the UK broker reported yesterday that it had a powerful start to 2018, posting a record monthly trading volume of $110.6 billion in January followed by triple-digit figures in February,March and May. Its key competitors Saxo Bank, CMC, IG have also reported stellar performance in 2018 due to increased volatility.

In reply to by bobcatz

Harry Lightning Life of Illusion Tue, 06/05/2018 - 05:35 Permalink

These EM bankers are so full of shit. They want free lunches, that's the bottom line. If they can't finance their dollar-denominated portfolios, then sell their dollar-denominated assets. But no, their greed prevents that from happening, as they don't want to miss out on what they think will be a never-ending ringing of the cash register in a US stock market than only goes up.

All of the major foreign banks have access to dollar funding through their US branches or through their correspondent banking relationships in the US. They can borrow in the overnight fed funds market, where there are a trillion dollars of free reserves sitting in banks' accounts at the Federal Reserve just waiting to be lent. The problem for these foreign banks is not that they cannot get funding, their real problem is that their profit margin has shrunk considerably as the Fed tightened interest rates, and if there is any more tightening many of their assets will become negative carry, meaning they lose money on the asset.

The Fed knows this full well, and all the EMs do by making these phony arguments is guarantee the Fed will continue with its plans to drain liquidity from the global dollar market. It does no good to try to jawbone the Fed into changing policy, especially when the jawboning is deceitful.The EMs should suck it up and take their losses. They were stupid enough to buy assets that had such low yields, now its time for them to learn how to be traders instead of clerks.

In reply to by Life of Illusion

looks so real Harry Lightning Tue, 06/05/2018 - 08:12 Permalink

The EM views it that the U.S. is paying them to use the dollar the threat is they switched to yuan.Most of the money given to them comes back to the U.S. like giving welfare recipients money it all goes into corporate profits.The bottom line is either we control and give money and make the rules or some one else does right now dollar use is 88% of world Trade.My thoughts is keep giving out money it works really well.

In reply to by Harry Lightning

Curiously_Crazy sabaj49 Tue, 06/05/2018 - 00:06 Permalink

You must be new here.

My Grandfather said essentially the same thing since the 70's when Nixon took the US off the gold standard to avoid default. Grandpa died a while back but his gold remained, some of which was handed down to me which I was grateful to add to my collection.

I was late to the party in terms of actual stacking (90's) and was saying the same thing up until a few years ago myself.

Yes - everything will go down in a shitstorm at some stage, but a lot have come to the realisation that they can push this joke of a system on for a hell of a lot longer yet.

In reply to by sabaj49

shortonoil Helena Bonham-Carter Tue, 06/05/2018 - 06:33 Permalink

This is not a surprising response from a nation that imports 80% of its oil. Neither is it surprising when the world is burning 9 barrels for every 1 it finds. This is how the end of the oil age will come about. Sorry India, but this is all about who will be the last man standing. Some member of the emerging market won't be that guy. Venezuela was not an anomaly, it is the standard for the world to come.


In reply to by Helena Bonham-Carter

BeanusCountus valerie24 Mon, 06/04/2018 - 22:43 Permalink

Wait... what?  There are more $ around than there should be due to all of the monopoly money created during financial “crisis” (bullshit term, but will go with it).  There is no shortage.  The $ is going to get stronger because all the fake shit is going to be taken away?  After a period where it has gone up, up, up due to raising interest rates to a whopping 3% on the 30 yr?  When inflation might be on the move?  Nonsense.  This is all a “flow” thing, not a “fundamentals” thing.  Short term at best. It will pass.  And my guess is gold is going up.  Not down.  The damn $ is losing its long term status as “THE” reserve currency.  Drip, drip, drip.  Period.

In reply to by valerie24