The world’s most-traded currency is becoming a fear gauge.
That’s the opinion of Hyun Song Shin, head of research at the Bank for International Settlements. A stronger dollar can depress demand for credit while reflecting reduced investor appetite for the riskiest assets, Shin wrote in a report released Tuesday by the BIS.
The research signals that the dollar’s surge after Donald Trump’s U.S. electoral victory shouldn’t be interpreted as a clear sign of confidence across markets. In fact the dollar has become a new fear gauge, replacing the Chicago Board Options Exchange VIX volatility index, Shin wrote.
“The mantle of the barometer of risk appetite and leverage has slipped from the VIX and has passed to the dollar,” he said. “Given the dollar’s role as barometer of global appetite for leverage, there may be no winners from a stronger dollar.”
Years of monetary easing by global central banks has kept volatility low for stocks while compressing credit spreads. That has stripped predictive power from the VIX. At the same time it has pushed more international borrowers and investors toward the dollar.
Dollar Liabilities
Given the global increase in dollar-denominated liabilities, a stronger currency may lead to lower appetite for investment risk and reduced demand for dollar-lending to acquire relatively volatile assets, according to the report published by the Basel, Switzerland-based institution that represents central banks.
The VIX is a measure of implied volatility calculated from what investors pay for options on the S&P 500 stocks index. Before the financial crisis in 2008, there was a close relationship between leverage and the index, according to the research. When the VIX was low, borrowing appetite increased and vice versa.
The crisis, however, forced policy makers to cut borrowing costs to record lows, quelling price swings. The gauge, which has averaged about 16 this year, was a far cry from record 80.9 almost eight years ago.
Negative Interest Rates