Stocks are surging today amid a dovish punch from Fed whisperer Nick Timiraos followed a few hours later by the otherwise hawkish Mary Daly, and the reason for this particular dovish reversal and jawboning is becoming increasingly clear: the same reason we have been warning for the past year that the Fed’s tightening campaign will break something, or something but a very explicit – and quite massive – dollar funding shortage and short-squeeze.
BofA Chief Investment Strategist Michael Hartnett (whose latest weekly note we will dissect shortly) has a favorite saying for when critical phase (to avoid the most hated word in the world “paradigm”) shifts take place in the market, one which may be the only word a trader in this day and age needs (or rather hopes for): “
So in what may be the best news to shellshocked bulls after the worst September and worst Q3 in generations, in a harrowing year for markets, central banks are starting to panic more with every passing day. First it was the BOJ with its September intervention, then the BOE with its bailout of pensions, then the BOJ again with its second consecutive injection of billions of US dollars into the market – consider the paradox: there is such a massive USD short squeeze out there that it was the Bank of Japan that was compelled to inject approximately $40 billion in USD today (in only its second intervention this century) to prop up the yen since the Fed won’t lift a finger…
… and now, for the third week in a row, it’s Switzerland’s turn.
Recall that one month ago, after the (first) panicked pivot by the BOE, when global markets were in freefall, we said that markets desperately needed some words of encouragement from the Fed, or failing that – and with the dollar soaring to new all time highs every day – the Fed had to make some pre-emptive announcement on USD Fx swap lines, if only to reassure global markets that amid this historic, US dollar short squeeze, at least someone can and will print as many as are needed to avoid systemic collapse.
Fed has to issue FX swap line press release before open
— zerohedge (@zerohedge) September 26, 2022
So fast forward two weeks to October 5, when there still hasn’t been any formal announcement from the Fed, but ever so quietly the Fed shuttled $3.1 billion to the Swiss National Bank to cover an emergency dollar shortfall, as we first reported a few days ago.
Remarkably, this was the first time the Fed sent dollars to the SNB this year, and the first time the Fed used the swap line in size (besides a token amount to the ECB every now and then)!
But it certainly wouldn’t be the last time – as we have warned, expect far wider use of Fed swap lines as the world chokes on the global dollar shortage – and sure enough one week later, the Fed announced that it had doubled the size of its USD swap with the world’s most pristine economy and its central bank, the Swiss National Bank, sending some $6.27 billion to avoid an emergency funding crunch.
… And then, just when people thought that things are set to normalize with Credit Suisse stock surging, it doubled it again, and in the latest week, the Fed almost doubled the amount of US liquidity it sent to Switzerland from $6.3 billion to $11.1 billion…
… a number which is roughly doubling every single week. Remarkably, this was not only the third consecutive time the Fed sent dollars (in size) to the SNB this year, but the largest single USD swap transfer in history!
The next logical question obviously is: why does Switzerland have a financial institution needing over $11 billion in cheap (3.33%) overnight funding – up from $3 billion two weeks ago. We don’t know the answer, but have a pretty good idea of who the culprit may be courtesy of Goldman which earlier this week issued the following competitor warrant.
And speaking of the coming crisis, recall what we said at the start of September: the coming Fed pivot will have nothing to do with whether the Fed hits or doesn’t hit its inflation target, and everything to do with the devastation unleashed by the soaring dollar (a record margin call to the tune of some $20 trillion) on the rest of the world.
BBG dollar index 1300, back over covid panic highs, and new record as dollar margin call sweeps emerging markets. Pivot will not come from “inflation target is hit” but from devastation across ROW pic.twitter.com/C3h15bko0B
— zerohedge (@zerohedge) September 1, 2022
Here will will again remind readers of what Bob Michele, the outspoken chief investment officer of J.P. Morgan Asset Management, told everyone a few weeks ago as paraphrased by Bloomberg, when he said that said “the relentless dollar could forge a path to the next market upheaval.”
Michele has been in de-risking mode, sitting on a pile of cash which is near the highest level he has held in 10 years. And he is long the dollar. While a market crisis sparked by the greenback is not his base case, it’s a tail risk that he is monitoring closely.
Here’s how it could happen: Foreigners have snapped up dollar-denominated assets for higher yields, safety, and a brighter earnings outlook than most markets. A big chunk of those purchases are hedged back into local currencies such as the euro and the yen through the derivatives market, and it involves shorting the dollar. When the contracts roll, investors have to pay up if the dollar moves higher. That means they may have to sell assets elsewhere to cover the loss.
“I get concerned that a much stronger dollar will create a lot of pressure, particularly in hedging US dollar assets back to local currencies,” Michele said in an interview. “When the central bank steps on the brakes, something goes through the windshield. The cost of financing has gone up and it will create tension in the system.”
The market probably saw some of that pressure already: as we noted at the time, investment-grade credit spreads spiked close to 20 basis points toward the end of September. That’s coincidental with a lot of currency hedges rolling over at the end of the third quarter, he said — and it may be just “the tip of an iceberg.”
Indeed it was, and since then things have only gotten worse… and will keep getting worse, because here is Michele is what he thinks happens next: as Bloomberg writes, “the central bank will be so committed to combating inflation that it will keep raising rates and won’t pause or reverse course unless something really bad happens to markets or the economy, or both. If policy makers pause in response to market functionality, there has to be such a shock to the system that it creates potential insolvencies. And a rising dollar might do just that.”
Needless to say, the fact that the Fed is already quietly shuttling of dollars to various central banks to plug dollar overnight funding holes, confirms that the rising dollar has already just that. One look at the meltup in FRA-OIS – the most widely used indicator of interbank of funding and liquidity – which just hit a fresh 2022 high, is enough confirmation.
As for what happens next, we suggest that you i) quietly panic if you are still short USD – and hoping for the Fed to come to the rescue – because at last check (March 2020) JPMorgan calculated that the global dollar short was $12 trillion with a T, or some 60% of US GDP, a number which has conservatively grown to about $20 trillion as of today…
… and ii) keep a very close eye on the visitors to this particular tower…
… and this particular hotel.