World markets are facing a simple but serious problem: There just aren't enough dollars to execute trades and transactions.
That explains why the trade-weighted dollar index, gained more than 4% last week. The broad dollar index measures the value of the dollar against a basket of currencies, namely the euro, pound, yen, Canadian dollar, Swiss franc and Swedish krona.
Given the scarcity of dollars, the U.S. Federal Reserve last week announced that it set up financing channels with nine other central banks, including the Reserve Bank of Australia and Monetary Authority of Singapore, to stabilize currency markets.
That opened access to $450 billion of additional dollar funds, with a commitment to keep the arrangement in place for at least six months.
However, analysts aren't sure if that amount will be enough to contain the fear among investors who are hoarding dollars as market gains evaporate.
Khoon Goh, head of research at Melbourne-based ANZ Bank, thinks the greenback will rise to 105 on the dollar index in the short term. As of Tuesday it stands near 102, and last was at 105 in late 2002.
"The swap lines will help to some extent. However, it is unlikely to be sufficient given the extent of dollar demand. From a technical perspective, the dollar looks overbought, so some consolidation can be expected. However, this is likely just a pause before another push higher," Goh told CNBC in an email.
The Fed announced open-ended additional stimulus on Monday, and Goh acknowledged that some steam came off the dollar rally.
"We will probably see the greenback consolidate for a while, but the key will be how other major central banks respond as well," he said. "If the (European Central Bank) and (Bank of Japan) also start to announce more measures of their own, that could still push the dollar index toward 105 over the short term."
The dollar spike isn't surprising given extreme market volatility and investor fears that go along with it. But a number of aspects to the rise are worrying some analysts:
Any solution to the dollar frenzy is linked to an eventual easing of the coronavirus infection rate, said Goh.
"We will need to see the COVID-19 new infection numbers peak and start to trend lower before we see a bottom to the risk selloff and a turn in the dollar strength," he said.
However, Divya Devesh, of Standard Chartered, said the moves by the Fed could be a silver lining to unabated dollar demand. The objective of those daily operations is to convince market participants that sufficient dollars will be readily available. That in turn should support financial institutions in lending to each other more confidently. "It is all about signaling," Devesh said.
The number one risk for world markets associated with dollar shortfall, is a potential rise in defaults.
Traders are watching the spread between two bank lending rates, the London Interbank Offered Rate (LIBOR) and the Overnight Indexed Swap (OIS). Since 2008, that spread has been seen as a warning sign of credit risk within the banking industry.
"The key issue facing policy makers is to ensure that the economic challenge doesn't lead to an insolvency event," Divya says.
He believes that the policy response, globally, has so far been strong and is likely to get more aggressive in the coming weeks.
"In the meanwhile," he said, "the markets will remain on high alert given the risks of an unintended spill over to credit markets."