Investing.com - The global financial system is entering uncharted territory, according to Deutsche Bank (ETR:DBKGn), noting a confidence crisis in the U.S. dollar.
“We are witnessing a simultaneous collapse in the price of all U.S. assets including equities, the dollar versus alternative reserve FX and the bond market,” said analysts at Deutsche Bank, led by George Saravelos.
In a typical crisis environment the market would be hoarding dollar liquidity to secure funding for its underlying U.S. asset base, likely triggering the Fed swap lines.
The dynamics here seem to be very different, the bank said.
“The market has lost faith in U.S. assets, so that instead of closing the asset-liability mismatch by hoarding dollar liquidity it is actively selling down the U.S. assets themselves,” Deutsche said.
U.S. administration policy is encouraging a trend towards de-dollarization to safeguard international investors from a weaponization of dollar liquidity.
“We are now seeing this play out in real-time at a faster pace than even we would have anticipated,” the German bank said. “It remains to be seen how orderly this process can remain. A credit event in the global financial system that threatens the provision of short-term dollar liquidity is the point of greatest vulnerability which would turn dollar dynamics more positive.”
The first order effect of current policy is of course the generation of a large negative supply-side shock that raises inflation and makes it harder for the Fed to cut rates.
A policy objective of reducing bilateral trade imbalances is functionally equivalent to lowering demand for U.S. assets as well. This is not a theoretical consideration, the bank said, the U.S. has this week initiated trade negotiations with Japan and South Korea, with a specific reference to currency levels being a negotiating objective.
“It should not be overlooked that Japan is the largest official holder of U.S. Treasurys. An implicit negotiating objective of lowering USD valuations entails the possibility of the sale of U.S. Treasurys from the Japanese Ministry of Finance,” Deutsche Bank said.
At the epicenter of the last few days' escalation is the trade war with China - with a 100%+ tariff on China, there is little room now left for an escalation on the trade front.
“The next phase risks being an outright financial war involving Chinese ownership of U.S. assets, both on the official and private sector front. It is important to note there can be no winner to such a war: it will damage both the owner (China) and the producer (US) of those assets. The loser will be the global economy,” Deutsche Bank added.