Monday, December 8, 2014

Oh Crap: There's An Oil Angle In The BIS' Warning On Market Instability

Izabella has been fleshing out the petrodollar story* over the course of the last few weeks and now ties it into the BIS story.
If you'll excuse me a moment I have to brush the dust off some esoteric hedges.

From FT Alphaville:
These are not the dollars you’re looking for
The big story on Monday is the warning from the BIS that a resurgent dollar could disrupt EM markets due to the fact that collectively the region has three quarters of its $2.6tn debt denominated in the US currency.
Meanwhile, international banks’ cross-border loans to emerging market economies amounted to $3.1tn in mid-2014, mainly in US dollars, the BIS added.

And herein lies the key problem associated with the hypothetical eventuality of no more petrodollars. A major dollar squeeze in foreign eurodollar markets.

Not that the petrodollar is near its death just yet — the US after all is nowhere near energy dependent.
But we are, nevertheless, at a point where the fall in oil prices is beginning to stifle an important channel of US dollars to foreign markets, markets which happen to be increasingly exposed to dollar strength due to their acquisition of major dollar denominated liabilities throughout the years when financing in the currency was cheap. Many of which liabilities, we should add, are not captured by BIS capital flow data due to the use of offshore subsidiaries.

The key thing to understand in that regard is how this sets up markets for a potential bifurcation of the dollar market, wherein lookalike eurodollar assets begin to breakaway from bona fide US dollar assets held in domestic accounts. Arguably, with everyone getting confused about what’s happening due to the ongoing presumption that eurodollars intermediated abroad are one and the same thing as dollars intermediated at home.

Some worthwhile background to all this comes by way of a UBS report from strategist Syed Mansoor Mohi-uddin back in June, 2014.

As he noted at the time, petro-economies have for years been under pressure to diversify their petrodollar investments. This is partly due to the low-yield factor in conventional US dollar denominated safe assets but also the unappealing state of European assets. According to Mohi-uddin, this resulted in sovereign petro economy funds becoming less likely to diversify out of greenbacks into euros, and much more likely to seek risk in sterling, commodity currencies and… most of all, emerging markets....MORE
*
Nov. 28
Nigeria's petrodollar exposure
Nov. 24 
On the hypothetical eventuality of no more petrodollars