Something curious took place one month ago when the PBOC announced on April 17 that it would cut the reserve requirement ratio (RRR) by 1% to ease financial conditions: it broke what until then had been a rangebound market for both the US Dollar and the US 10Y Treasury, sending both the dollar index and 10Y yields soaring...
... which led to an immediate tightening in financial conditions both domestically and around the globe, and which has - at least initially - manifested itself in a sharp repricing of emerging market risk, resulting in a plunge EM currencies, bonds and stocks.
Adding to the market response, this violent move took place at the same time as geopolitical fears about Iran oil exports amid concerns about a new war in the middle east and Trump's nuclear deal pullout, sent oil soaring - with Brent rising above $80 this week for the first time since 2014 - a move which is counterintuitive in the context of the sharply stronger dollar, and which has resulted in even tighter financial conditions across the globe, but espetially for emerging market importers of oil.
Meanwhile, all this is playing out in the context of a world where the Fed continues to shrink its balance sheet - a public sector "public Quantitative Tightening (QT)" - further tightening monetary conditions (i.e., shrinking the global dollar supply amid growing demand), even as high grade US corporate bond issuance has dropped off a cliff for cash-rich companies which now opt to repatriate cash instead of issuing domestic bonds, with the resulting private sector deleveraging, or "private sector QT", further exacerbating tighter monetary conditions and the growing dollar shortage (resulting in an even higher dollar).
And while the latest incarnation of the dollar's "impossible trilemma" - rising dollar, rising oil, rising yields (not to be confused with its more conventional Chinese variant) makes a short, if perplexing appearance, ultimately it's all about the value of the dollar, and its impact on downstream assets and volatility.
This is the point made by Deutsche Bank's derivatives expert Aleksandar Kocic, who in his latest report writes that in the context to the Fed's normalization and monetary policy fine tuning, the "USD is emerging as the key variable -- it presents a compact summary of the underlying macro risks that could destabilize the current Fed path." In other words, the last thing the Fed wants right now as it accelerates its balance sheet normalization, is a sharp spike in the dollar. And yet, that's precisely what is happening. Kocic explains:
A strong USD corresponds to generally hawkish Fed in an environment where the US is recovering fast while the rest of the globe is still too slow or recessionary, or that the Fed is pushing rates above the neutral and causing excessive tightening of financial conditions and potentially...