Quantitative Easing

Column: Unraveling Central Bank Consensus Stimulates Dollar and Market Tensions

A euro banknote is displayed on US dollar banknotes in this illustration taken February 14, 2022. REUTERS/Dado Ruvic/Illustration/File Photo

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ORLANDO, Fla., May 3 (Reuters) – The highest inflation in decades is eroding the policy consensus that has existed among the world’s major central banks since the Great Financial Crisis and global markets could crumble under waves of stress and resulting volatility.

A supercharged dollar, which often both reflects and fuels financial market stress, risks creating a vicious circle as the run on the dollar intensifies, tightening global financial conditions and increasing volatility.

The rise of the dollar to its highest level in 20 years reflects not only the aggressiveness of investors who expect the Federal Reserve to raise interest rates, but also the fragmentation of the global landscape of central banks.

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While the US monetary authority appears to be engaged in the most aggressive tightening cycle since 1994, both in magnitude and speed, others are in various stages of fighting inflation and with varying degrees of appetite for the fight.

The Fed’s expected trajectory contrasts sharply with its three major peers. Central banks in Japan and China continue to ease policy and the European Central Bank will struggle with its tightening plans amid recession fears following a Ukraine-related energy shock.

Regardless of the course taken by the major central banks, the explosion in global inflation and the fragmented policy response have set global market volatility on fire – implied volatility for US Treasuries is the highest since 2009 and global financial conditions are also the toughest in 13 years.

As Bank of America analysts put it, two years of pandemic-fueled quantitative easing worth about $11 trillion globally is coming to an end and the ‘anchor point for volatility’ was removed, threatening the disorderly moves in rates and currency markets that policymakers are desperate to avoid.

“Market panics (are) often associated with divergent central bank policy objectives,” BofA wrote on Friday.



The dollar index, a measure of the value of the greenback against the six major currencies, is the highest since 2002. Although it has risen rapidly this year and may be due to a pause in catches earnings, many analysts believe there is room for further appreciation.

A stronger dollar makes servicing dollar-denominated debt more expensive for foreign borrowers. According to estimates by the Institute of International Finance, more than $1 trillion of debt held in emerging economies will come due by the end of next year.

The rising dollar and US borrowing costs have hit global financial markets – the S&P 500 just posted its worst January-April performance since the 1930s, while US bond market volatility and the Goldman Sachs’ global financial conditions are the highest since 2009.


The additional problem facing policymakers is essentially the irrationality and herd behavior of financial markets. Once traders sense weakness or a fracture, they go for the jugular, and market overshoots can exacerbate underlying economic issues.

In a speech on March 17, Isabel Schnabel, a member of the ECB’s executive board, underlined the danger of allowing policy divergence to widen too much.

“A reaction function that differs significantly from that of other central banks facing a prolonged period of above-target inflation risks amplifying the energy price shock by weighing on the exchange rate, thus increasing the the burden on real household income,” she warned.

Chris Marsh, a senior adviser at Exante Data and a former economist at the International Monetary Fund, says the Great Divergence can only continue for so long before other central banks are forced to follow the Fed.

“If the ECB and others don’t follow, they end up importing inflation. And inflation is already very high. So not following the Fed will be very difficult for them,” Marsh said.


Related columns:

Given what followed, emerging markets fear the 1994 Fed redux (Reuters, April 25) read more

Inflated dollar aggravates global liquidity crunch (Reuters, April 22) Read more

Hedge funds’ bullish dollar view distorted by yen outlier (Reuters, April 18) Read More

Euro foreign reserve demand returns after years of neglect (Reuters, April 13) read more

(Views expressed here are those of the author, columnist for Reuters)

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By Jamie McGeever; Editing by Andrea Ricci

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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and freedom from bias by principles of trust.