As interest rates fell, in some cases to negative levels, investors searched for higher-yielding assets. Given the global role of the dollar as a borrowing currency of choice, most of those assets are denominated in U.S. currency. Long-term yields for dollar securities, for example, have been higher than similar-maturity bonds in Japan, the euro area and Switzerland.
For institutional investors with global portfolios of assets, they need to mitigate the risk of currency mismatches between assets they hold and domestic liabilities. This involved hedging, which is mostly done through banks. These banks also lay off their own risk by borrowing dollars. This demand implied a dollar “shortage” that made the financial sector more vulnerable to the strength in U.S. currency, BIS researchers said.
“The risk-taking channel of exchange rates turns on the impact of dollar appreciation in a world where many balance sheets have dollar liabilities,” they said. “When so many borrowers have borrowed so much in dollars, whether for hedging or speculative purposes, dollar appreciation exposes borrowers and lenders to valuation changes and, in turn, impacts their balance sheets.”
This article was provided by Bloomberg News.