Just like consumers started a run on toilet paper, companies and institutions all over the world have created a shortage of dollars, as some players hoard more of the currency than they immediately need in response to fears about the coronavirus.
In times of trouble, all sorts of companies, banks and investors want to hold dollars. It is the world's reserve currency and considered the safest.
So as financial markets careen, the demand for dollars is huge, and it's exacerbating dislocations across financial markets. The demand is coming from all sorts of sources — banks, issuers of dollar-denominated debt; investors selling dollar-based assets; companies looking for cash for U.S. operations; and foreign banks looking to help customers. All of them are pressuring the currency.
Investors have been selling financial assets around the world and that has been fueling even more demand for dollars and has been sending currencies lower. The selling has also snowballed, triggering even more asset sales, and more need for dollars.
The Federal Reserve is expanding existing swap lines and adding lines to more central banks so that whatever institution needs dollar funding can have better access to it.
Even with the Fed's efforts, the U.S. dollar index continues to surge. The dollar index Thursday jumped 1.5% to 102.70, on top of a stunning rally since March 9, when it was only 95.
"As soon as the Fed announced the swap line with Australia, the Australian dollar was one of the hardest hit, and it snapped back," said Marc Chandler, chief market strategist at Bannockburn Global Forex. The Australian dollar had fallen to an 18-year low of $0.55 per U.S. dollar, before rising to $0.577, roughly flat on the day.
The Federal Reserve opened new swap lines Thursday with central banks in Australia, South Korea, Brazil and Mexico, among others, to help them deliver dollar funding to institutions in their regions. Chandler said the Bank for International Settlements estimates dollars are used to fund about $17 trillion in assets globally.
But that did not solve the broader problem, with the dollar still rallying against other currencies globally. It was 2.2% higher Thursday against the euro and up 2.4% against the yen. The euro was at 1.06 to the dollar.
"These are very sharp moves," said Chandler. "What makes them sharp is partly that things were so calm before. These are also very elevated historically." Chandler said for instance, three-month implied volatility for euro/dollar is at 14%, nearly three times above its 200-day moving average of 5.4%.
The wild 8% move in the dollar in little over a week has also prompted market talk of a possible intervention by G-7 governments to bring down the dollar.
"I think that it's going to prove necessary.The big dollar rallies we've had ended with intervention. The first line of defense is to go to the swap line and let the swap lines work. I think we need another week to see if the increase in swap lines and the lower rates will ease the dislocation," said Chandler. "I think the market is telling us they probably won't."
Chandler said the last time there was a major intervention, it was to help Japan after the tsunami in 2011. The most famous intervention in recent history was the 1985 Plaza Accord to stop the dollar from surging and prevent inflation from building in other economies.
"I don't think the Europeans are worried about how weak the euro is," said Chandler. "I think we have a little work to do to get to the conclusion that a high bar for intervention is necessary."
Bank of America strategists say the dollar may move just a few percent higher before the U.S. starts to seriously discuss an intervention to weaken the dollar.
"Floating exchange rates are designed to address economic and terms-of-trade shocks such as this. A key tradeoff is shock absorption vs. market disorder and capital flight risk," the BofA strategists wrote. "But because the virus is global, weak FX translates to tighter US financial conditions. Consequently, we suspect that the US could begin to push for a coordinated FX response with DXY above 104 and EUR/USD below 1.05 (highest and lowest levels since 2002)."
Deutsche Bank FX strategist Alan Ruskin said there's a clear mismatch in the market, driven by rapid market moves and the sudden rush by companies and institutions to move to cash.
"I think it's very hard to get dollars to the people who may need them most. There's a variety of sources [seeking dollars]. Some of it is just bank related," said Ruskin.
"That's a little like 2008. There's a pretty obvious ingredient going on right now where some of the largest companies are drawing down their credit lines. That's one of the more visible aspects of something that is more a plumbing type thing," Ruskin said.
There is also an element of investors favoring U.S. assets as a shelter, but this week's selling in Treasurys, the ultimate safe haven, was in part due to investors selling bonds to raise dollars.
Strategists said, like the households that grabbed all the toilet paper from store shelves, some institutions see the surge in demand as a reason to take more dollars than they now need.
Companies drawing on credit lines threw another heavy drag onto the system. "Everyone draws down their credit lines because they think 'I better get that liquidity when it's still good,'" said Ruskin.
Ruskin said all sorts of institutions and companies appear to be hoarding dollars. "They normally were getting that money through swap lines, and they find that source was drying up, and they might hold on to that liquidity as well, knowing there's considerable demand," he said.
"If you can get credit, you'll take it basically. It's not costing you very much … I think the financial institutions have had experience in the past, and they want to hold onto liquidity as well. It's not as easy to get to non-U.S. banks. That's where you're seeing the stress in the currency market," said Ruskin.
Strategists say the situation is also very different than 2008, when institutions feared counter-party risk and banks were afraid of dealing with each other. This time, the pandemic coronavirus has created an unknown hit to the economy as cases begin to rise globally, including to 10,000 in the U.S. That makes all sorts of institutions and companies want to hang on to as much cash as possible, and they want it in dollars.
"There's almost a sharper edge in a way, in so much as there's some sense of totality," Ruskin said. "It's hitting such a substantial part of the economy in a complete way - literally visible shut down."
When Lehman Brothers closed in 2008, there was a concentrated impact on the financial sector and housing. "This has a different feel to it. It's clearly global and in certain sectors there's a complete shutdown and then there's the financial angle … which is only now kicking in," Ruskin said.