LONDON - Central bank body the Bank for International Settlements has flagged a possible scramble for dollars could be triggered if whipsawed investors begin to unwind positions in the $113 trillion FX swap market amid US volatility.
The BIS recently estimated that funds and other non-bank financial firms had more than $80 trillion in FX swaps - money borrowed in the US currency with the promise to pay it back at an agreed exchange rate at a later date.
Effectively a form of short-term debt, swaps tend to be held 'off balance sheet' and are not to be factored in regulatory capital requirements.
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The issues come if investors suddenly rush to unwind these positions, the head of the BIS' monetary and economics department, Hyun-Song Shin, said in a lecture at the London School of Economics.
Investors who have hedged positions are often holding euros or yen but still have the dollar repayment obligations.
"If you have to roll over that swap you have to join the scramble (for dollars)," Shin said, adding that can then cause a rapid spike in the value of the US currency.
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The comments come after market turmoil in April when President Donald Trump launched the US into a full blown trade war and consigned the dollar to its weakest start to a year in over 35 years.
On Friday too, Moody's stripped the US of its last remaining triple-A credit rating, underscoring concerns about the huge increase in US government debt over the last 15 years.
Shin also touched on whether US exceptionalism - investors' strong preference and incentive to buy US assets - had been eroded by this year's turbulence.
He noted the highly unusual combination of US stocks, bonds and the dollar all selling off in tandem but said it was still too soon to know whether major investors were selling down their US assets or just hedging.
However, they are likely to be at least thinking about whether strategic changes might be warranted, Shin added.
