The resurgent ‘Trump’ dollar is setting off an incipient credit crunch across large parts of the world economy, forcing countries to tighten monetary policy or intervene in the exchange markets to defend their currencies.

The dollar index (DXY) reached a fresh 14-year high of 102 overnight as global markets rotate violently into the US “reflation trade’, betting that Donald Trump’s eye-watering fiscal expansion will prove a replay of Reaganomics in the early 1980s.

Rocketing US bond yields have triggered a global stampede into US assets, draining the international system of dollar liquidity. It is the exact opposite of what happened in the glory days of the emerging market boom when quantitative easing by the US Federal Reserve flooded the world with cheap dollar credit.

The Indian rupee fell to a record low of 68.87 to the dollar on Thursday as foreign investors continue to pull money out of emerging market funds at the fastest rate since the China panic last August.

Traders say China’s central bank has been intervening heavily over recent days to slow the slide in the yuan, fearing that capital outflows could escalate into a full blown-cascade. The currency reached a six-year low of 6.96 against the dollar on the offshore market in Hong Kong, approaching the psychological threshold of 7 RMB that could the rattle nerves of Chinese investors.

Interbank lending rates have climbed for the last eleven days in a row in Shanghai, an even longer stretch than during the ‘taper tantrum’ in May 2013 when the Fed first began to talk tough. Shibor rates have been spiking across all maturities.

“In our view this could be even more serious than the taper tantrum in 2013,” said Stephen Jen from Eurizon SLJ Capital.

Mr Jen said higher bond yields and borrowing costs may be appropriate for America in its current particular circumstances, but they are toxic for most emerging markets still struggling with the fall-out from debt bubbles. 

“The US is out of synch with the rest of the world, and under Trump there will now be an ‘America First’ policy so they won’t to care what happens to anybody else,” he said.

The core problem is that global finance is more dollarized today than at any time in history, with $10 trillion of dollar debt trading globally outside US jurisdiction and beyond full control, up fivefold since 2002.

David Fuller's view

This is why I expect to see a continuation of somewhat choppy stock markets over the next three to four years as the world moves away from quantitative easing (QE), towards infrastructure spending leading to a gradual improvement in the global economy and an eventual normalisation of interest rates, albeit at lower levels than we have seen in previous cycles over the decades. 

The main reason for this is the disinflationary influence of an accelerating rate of technological innovation, which has many benefits in terms of efficiencies and keeping inflation lower than in previous cycles over the last several decades.

Clearly, the global economy is not synchronised in this process of emergence from QE.  Instead, the world’s largest economy is running ahead, while the European Union (EU) and some emerging and frontier markets are lagging well behind.  This will cause some turbulence, leading to risks but also opportunities.  I have discussed this in more detail in the Friday big picture Audio. 

Here is a PDF of Ambrose Evans-Pritchard’s article.