Happy Wednesday! 🐪

📝 Focus

• USDedollarisation

📊 In the Markets

• Risk-off, Debt Ceiling Puppets, Euro-inflation, Weak Oil, Short seller vs Activist

📖 MoneyFitt Explains

🎓️ The Dollar Index... the flawed DXY

📝 Focus

USDedollarisation

The “end of dollar dominance” movement has always had its supporters but has grown in momentum recently due to a combination of political and economic factors.

Dollar dominance refers to the overwhelming use of the United States dollar (USD) as the world's primary reserve currency (currently 60% of official foreign exchange reserves) and the dominant currency for international transactions, such as trade and financial transactions.

The end of dollar dominance could lead to the emergence of one or several new world reserve currencies, such as the Chinese yuan, heightened volatility in financial markets (the USD provides some stability), and a reduced economic and political influence of the US, which would please the likes of China and Russia amongst others.

The dominance of the USD is down to several reasons, such as:

• The US economy is the largest in the world, with extensive, liquid capital markets supported by the rule of law and military power.

• Oil, an essential commodity to businesses globally, is priced in USD. Petrodollars, a term used for crude oil export revenues in USD, make up the majority of revenue and wealth for OPEC countries, plus non-OPEC oil and gas exporters such as Russia and Norway.

• Oil exporters prefer to trade in USD as it is a more practical store of value, and they can easily invest dollars compared to receiving revenue in an importer’s lesser-used currency. Most other commodities are also priced in USD.

However, there is an increasing trend of countries utilising currencies other than the US dollar in international trade.

And so, the de-dollarisation movement has so far led to:

• Anwar Ibrahim, the Prime Minister of Malaysia, proposed the re-introduction of a scheme for the creation of an Asian Monetary Fund. The fund would denominate central bank reserves in currencies other than the US dollar.

• In March, China and Brazil reached an agreement to conduct trade using their respective currencies.

• In the same month, Saudi Arabia consented to become a member of the Shanghai Cooperation Organization, an organisation led by China that focuses on political, economic, and security issues.

• France seems most open to the concept out of the Western allies. TotalEnergies, a French oil company, carried out China's first liquefied natural gas trade settled in yuan.

After all, there are strings attached to transacting in USD; for example, it makes a country susceptible to the US, aka “the world’s policeman”, and its allies sanctioning them. The United States can restrict governments, institutions and individuals from receiving payment for exports in USD, using USD for payment or owning USD-denominated assets.

The sanctions imposed on Russia in 2022 for invading Ukraine catalysed increased “de-dollarisation”. The weaponisation of financial sanctions serves as a warning to many developing nations that they could be next. Astoundingly, 30% of the world is under sanctions imposed by either the US, EU, Japan or the UK, significantly higher than 10% in 1990.

The actions are unlikely to end the dollar’s main strength, its dominance as a currency for global trade, though it should be noted that these bilateral currency settlement trades do aim to reduce the dollar’s use for global trade, (the benefit to the US as the issuer of the US dollar is known as seigniorage).

For example, Russia and China agree to settle Russian natural gas exports to China in yuan rather than USD. This means that China is no longer paying Russia in dollars, so it does not need to hold as many dollars in reserve, and Russia no longer has to use the dollars it received from China to buy goods and services from other countries or exchange them into roubles.

For there to be an end to dollar dominance, there needs to be an alternative, which the effort to find is certainly underway.

Gold, the oldest and most traditional asset, has increased in price by 20% over the past six months as central banks look to hedge against inflation and low real interest rates.

Interestingly, a closer look at where the buyers are coming from shows that 9 of the top 10 are from the developing world, including heavyweight economies (and pushing for de-dollarisation) China, India and Russia. These three countries, along with Brazil and South Africa, form a group of economies known as BRICS, looking to counter dollar dominance.

The petroyuan?

Of the BRICS nations’ currencies, only the Chinese yuan has been stronger than the US Dollar Index 🎓over the last five years. But the Chinese government is known to depress the value of the yuan to boost its export-oriented economy, which could make it a riskier holding.

The Chinese yuan is still making dents in the dollar’s dominance, though, potentially paving the way for a trade system properly rival to the US dollar. In March, more cross-border transactions with China were settled in yuan than dollars for the first time. It’s safe to say that dollar dominance is here to stay for the foreseeable future, but remember, there were other major reserve currencies before that!

📊 In the Markets

The selloff in mid-sized US bank shares continued, dragging down broader markets. Traders and short-sellers glommed onto what JPMorgan CEO said when his bank bought First Republic... not when he said it “pretty much resolves them all”, but his warning that “there may be another smaller one” to come. Potentially the next dominos to fall, PacWest Bancorp of Beverly Hills plunged 28% (see MFM from March), and Western Alliance Bancorp lost 15%. Fundamentally, mid-sized banks between $100bn and $250bn in assets are also attracting concern because regulators will tighten supervision and regulatory requirements, which comes with not-insubstantial costs. Weaker profitability is the tradeoff for less likelihood of going under and wiping out the shareholder base... So traders sell?

Risk-off: Traders also took a "risk-off" position heading into Wednesday’s Federal Reserve decision on interest rates. The likely 0.25% hike is hardly in doubt at this stage, even as the economy shows more signs of cooling (with job openings in March at their lowest in almost two years) and a potential "credit crunch" ahead, thanks to the ongoing banking crisis.

..... ▷ And then there's the looming debt ceiling (see 15-Jan MFM with an Explainer) which Treasury Secretary Yellen said could hit on June 1st rather than at the end of July, leaving even less time for GOP-Democrat horse-trading.

A mini-explainer on why we care about the US debt ceiling:

- The US Treasury market is considered one of the world's most liquid and stable markets, making it an important benchmark for other financial markets. It's the core building block for almost all asset valuations worldwide.

- Treasuries serve as a benchmark for valuing other fixed-income securities, such as bonds issued by corporations and municipalities. Treasury yields are often used as a reference rate for setting interest rates on loans and other financial products, such as mortgages and student loans.

- The US Treasury market serves as a benchmark for determining the risk-free rate, which is the rate of return on an investment with no credit risk. This rate is used as a benchmark for valuing other investments, including equities.

Eurozone inflation: European stocks were lower as eurozone data showed inflation in April RISING to 7.0% from 6.9% the previous month, its first increase in half a year, which of course, raised investors’ concerns that the European Central Bank would increase interest rates by another 0.25% this Thursday though this was already largely expected (as are further increases this year.) Asian trading was quietly mixed, with mainland China markets still shut until Thursday.

Weak oil: A day after OPEC+ began its latest production cuts, the oil price fell about 5% on fears of a looming recession given weak fuel demand in the US and China. Actually fits with OPEC+'s narrative of adjusting production in the face of risks to demand back in April when the cuts were suddenly announced on a Sunday (see April MFM with Explainers), rather than a conspiracy to "stick it to The West" as some were saying at the time.

..... ▷ This brings Brent Crude, the global benchmark for oil, to a 14% drop since then and a 12% drop in 2023 to date. (Natural gas prices are down more than 50% for the year.) Shares in large oil companies like BP, Shell, ExxonMobil and Chevron fell 3-5%, while the oilfield services giants like Schlumberger and Haliburton fell 6-9%.

Short seller vs Activist: Hindenburg Research, the short seller trying to take down Adani, announced it has a short position against famed --and feared-- activist investor Carl Icahn's Icahn Enterprises, alleging that it's been using proceeds from issuing new shares to pay dividends to existing shareholders and that some of its private assets are held at an “inflated valuation.”

..... ▷ Trading at above the net asset value of its holdings, Hindenburg says it's overvalued, especially against comparable, founder-centric activist investors like Bill Ackman’s Pershing Square and Daniel Loeb’s Third Point, which trade at a discount to their NAV.

📖 MoneyFitt Explains

🎓️ DXY, The flawed US Dollar Index

• Since currencies are measured against one another ("pairs"), one measure of how the US Dollar is performing against other currencies, in general, is to use the DXY (US Dollar Index, also the USDX.) The DXY rises when the USD is stronger than the other currencies in the basket and falls when it is weaker. Its all-time high was about 165 in 1985, and its all-time low was about 70 in 2008. It was originally set up by the Fed in 1973 and updated just once since, but just to adjust for the creation of the Euro in 1999.

• The index measures the USD against a basket of six currencies that are among America's main trading partners, EUR (Europe), JPY (Japan), GBP (the UK), CAD (Canada), SEK (Sweden) and CHF (Switzerland). EUR makes up 57.6% of the basket followed by JPY (13.6%) and GBP (11.9%.)

• The weightings are extremely out of date from a trading partner perspective, with the huge weighting of the Euro vs the ZERO WEIGHTING of the Mexican Peso (MXN) and the Chinese Yuan or RMB (CNY) the most glaring given that along with Canada they're the country's three largest trading partners by far. (Switzerland: #17, Sweden: #35!)

• Better alternatives exist (e.g. DTWEXAFEGS), but the DXY is still a handy, if flawed, way of getting a rough idea of the US Dollar's value. Partly thanks to its widespread use in derivative and ETF trading, it remains the most popular such measure by far.