In a paper published, in early 2015, by the Bank for International Settlements the authors successfully demonstrate that, while global banks are deleveraging, and reducing their US dollar credit to non-US borrowers, the Federal Reserve’s attempts at compressing the term premium, via its portfolio rebalancing channel, has pushed global bond investors away from low yielding US Treasuries and into higher yielding US dollar bonds issued by non-financials outside the US, more than offsetting the slowing credit growth of banks.
Please click on this link if you’d like to read the paper: BIS Working Papers – Global Dollar Credit
It brings to the fore a 9 trillion dollar question: How does a huge build up in US dollar credit to non-financial firms outside the US unwind when the Federal Reserve backs away from its ultra loose monetary policy?
In our view, this has great implications for EM Corporates, which have borrowed the most in US dollars. If you’ve borrowed in a foreign currency that starts appreciating relative to your own domestic currency, then your debt burden starts appreciating relative to your assets even if the nominal value of your debt stays the same. The US dollar rally, which has taken a temporary pause, may rear its ugly head once again in the not-too-distant future and may become self sustaining to the point where the world may have to look else where for its funding needs. A significant rise in the value of the US dollar, in our opinion, will eventually either result in its demise as the world’s reserve currency or Plaza Accord Part Deux.