By Marc Jones
LONDON (Wiseova) – The Bank for International Settlements has warned of potential turmoil as investors might rush into dollars if they start unwinding their positions in the $113 trillion FX swap market due to increased U.S. volatility.
The BIS recently estimated that funds and other non-bank financial entities held over $80 trillion in FX swaps, which involves borrowing money denominated in U.S. dollars with the commitment to repay it at a predetermined exchange rate at some future time.
Essentially a type of short-term borrowing, swaps are typically kept 'off the balance sheet' and do not factor into regulatory capital requirements.
The problems arise if investors quickly decide to close out these trades, according to Hyun-Song Shin, who leads the monetary and economic department at the BIS, during a talk at the London School of Economics.
Investors with hedged positions frequently hold euros or yen yet remain responsible for repaying their debts in dollars.
Shin stated that if you need to rollover that swap, you must participate in the competition for dollars. This situation can subsequently lead to a quick increase in the worth of the American dollar.
The remarks follow financial market disruptions in April when President Donald Trump initiated a comprehensive trade war with China, leading to the US dollar experiencing its poorest performance at the beginning of a year in more than three decades.
Also on Friday, Moody's downgraded the U.S.'s final triple-A credit rating, highlighting worries about the significant rise in U.S. government debt over the past 15 years.
Shin also touched on whether U.S. exceptionalism - investors' strong preference and incentive to buy U.S. assets - had been eroded by this year's turbulence.
He pointed out the very uncommon occurrence where U.S. equities, fixed-income securities, and the currency were simultaneously declining in value, yet he stated that it remained too early to determine if significant players were divesting themselves of American holdings or merely implementing protective measures.
However, they are probably at least considering whether strategic alterations may be necessary, Shin noted.
(Reported by Marc Jones; Edited by Sandra Maler)
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