Global dollar conditions: as simple as it gets, but the turning point is near
It may seem odd to talk about a tightening of external financing conditions, especially in US dollars, as these are easing day by day, but it is a risk that global markets are looking at a horizon of 12. at 18 months.
Right now, thanks to the purchase of $ 120 billion in assets per month and as the US Treasury depletes its account at the Fed to stimulate the economy, the supply of dollar liquidity is growing faster than Requirement. We are thus witnessing an increasing availability of financing in dollars, created by the Fed and made available to economic agents through a panoply of emergency measures put in place by central banks (eg: currency swap lines).
Higher on the yield curve and lower on the credit spectrum, some of that extra liquidity is used to seek returns on higher risk investments. Likewise, the funding premium commanded by the US dollar against a range of other currencies in currency swap markets is melting.
So what motive do we have for sounding the alarm bells at this point in the cycle? The $ 120 billion in additional bank reserves created by the Fed through QE will be wiped out by the end of 2022 at the latest.
There is also the fact that the turning point in the availability of dollar liquidity will be a prelude to the rise in US rates. In fact, a number of Fed hikes from late 2022 are built into the U.S. yield curve, but we argue that the path is far too shallow for the outlook for the U.S. economy.
So how are we going to get from here to there? We anticipate a first hike in intermediate rates, before the end of the year. These are the rates most directly affected by the Fed hikes, roughly the 2-5 year part of the curve. The shorter rates are expected to remain contained for at least another 6 months as liquidity will continue to increase for the whole of this year.
From 2022, these short-term rates will begin to rise due to the two hikes being considered within a year and as the marginal availability of dollar liquidity declines. From this point, the 2-5Y portion of the curve should start to flatten more and eventually reverse. We are also likely to see a widening of credit spreads in US money markets, for example Libor-OIS spreads, and a re-widening of cross currency bases against the dollar.