By Mike Dolan

LONDON- A rising dollar is turning the screw.

Borrowing rates are climbing across the planet as the world's major central banks, spooked by a dramatic return of inflation, start to reverse supereasy pandemic policies by lifting interest rates and dialling back bond buying.

The global liquidity pool that helped buoy the world through COVID-19 is draining. World financial conditions, measured by Goldman Sachs, are the tightest since the banking crash of 2008.

And the U.S. dollar's leading role in global finance and borrowing means the Federal Reserve's rapid conversion to the need for tighter credit compounds the problem worldwide - trumping other central banks with aggressive rate rises and boosting the dollar's exchange rate further.

Having already started its rate rise cycle with a quarter point hike last month, the Fed is now shaping up to tackle 40-year high inflation rates with one of the most brutal one year policy squeezes since the 1960s.

The most visible sign of that is a return this week to positive territory for 10-year real, or inflation-adjusted, yields for the first time since the pandemic hit.

Financial markets are pricing a blistering rise in Fed policy rates to as high as 3.5% by the middle of next year from just a quarter point now - and, strikingly, don't see 3-month dollar rates back below 3% for the rest of the decade.

What's more, the Fed is simultaneously set to allow its bloated $9 trillion balance sheet to wind down in a process dubbed 'quantitative tightening' - directly siphoning the pool of liquidity effectively stored in commercial bank reserves.

Unlike its peers, the Fed's heading for overdrive and its relative hawkishness has super-charged the dollar.

The greenback hit 20-year highs against Japan's yen this week as the Bank of Japan doubled down on its easy stance

It also hit 6 month highs versus China's yuan as the People's Bank of China looks to offset the effects of persistent COVID lockdowns and property sector jitters by bucking the trend and easing again - disappearing a yield premium on Chinese 10-year bonds over U.S. equivalents for the first time in 12 years.

And although the European Central Bank is also expected to lift interest rates this year, even the most hawkish pricing only has policy rates rising by less than a third of the Fed's mooted move over the coming 12 months. What's more, the euro zone's greater vulnerability to energy shocks resulting from Russian's invasion of Ukraine means that even that modest pricing is suspect and the euro hovers close to two-year lows.

Overall, the Fed's broad dollar index has appreciated almost 5% since the start of last year and the 'real' index is up almost 8%.


While a rising dollar is clearly a squeeze on overseas dollar borrowers, as well as those who need to fund dollar-based commodity purchases or trade financing, its impact can also be seen in the stark impact on aggregate dollar-denominated measures of global liquidity.

Liquidity specialist Michael Howell's CrossBorder Capital estimates that liquidity provided by major central banks jumped another $159 billion during March to $29.6 trillion, up some $7 trillion since before the pandemic.

But it's the changing pace of liquidity provision rather than absolute levels that's watched most closely by markets and these measures peaked well over a year ago.

In local currency terms, there's been signs of some stabilisation this month in 3-month annualised changes - gaining more than 2% in each of the past two weeks.

But that masks the impact of the rising dollar. In dollar terms, CrossBorder showed that the ebb of global central bank liquidity is actually accelerating and fell almost 10% on that annualised measure last week, compared with 6% the previous week and 3% before than.

Guessing the dollar's direction from here is a far trickier prospect of course. Some argue an aggressive Fed is amply discounted already and all the 'surprises' now lie with the other central banks. But others think the comparative Fed crunch will be unprecedented and not yet fully understood.

As for stocks, there's been some hope the sheer strength of the post-pandemic U.S. and European recoveries will mean outright recession will be avoided despite the coming liquidity drain and that bonds will take all the heat instead.

But that may be wishful thinking.

Attempting to explain why stock markets have been relatively stable this month in the face of all the hawkishness, Citi's global strategist Matt King concluded: "The reality is that tightening hasn't even started yet."

The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own

(by Mike Dolan, Twitter: @reutersMikeD; Editing by Kirsten Donovan)