Both the US dollar and US borrowing costs have rocketed in tandem since the election of Donald Trump as markets adjust for a reflation blitz, betting on the biggest fiscal stimulus in modern times.
The closely watched dollar index has jumped to a 10-month high of 99.02 and threatens to smash through powerful technical barriers, potentially sending it flying to levels not seen since the start of the century.
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Trump on economics
Donald Trump plans to radically shift the direction of America's economic policy.
Yields on 10-year US Treasuries - the benchmark price of global money - have jumped by 50 basis points to 2.08 per cent since late October, with knock-on effects for both sovereign and corporate debt in the rest of the world. British, French, and Italian yields have risen almost in lockstep with US Treasuries.
"At its core, Mr Trump's offering is reflation," said Kevin Gaynor from Nomura. How this plays out is extremely hard to judge.
What is clear is that the twin shocks of a soaring dollar and soaring rates could become a stress test for emerging markets and the world's fragile financial system.
David Woo from Bank of America said Mr Trump's plan for sweeping tax cuts, a defence build-up, and an infrastructure spree is akin to the policy mix of the early 1980s - which led to major currency upheavals.
"The last time the US unleashed fiscal stimulus when the economy was not in a recession was under Ronald Reagan [1981-1984]. This emboldened the Federal Reserve to enter a hiking cycle, propelling the dollar 60 per cent higher," he said.
Mr Woo said the Trump tax reform is designed to lure $US2 trillion ($2.65 trillion) of cash held by US corporations overseas. Some of this money is in foreign currencies.
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"Our estimates suggest that nearly $US400 billion ($530 billion)Â of overseas cash could be converted to US dollars," he said. This would turbo-charge the dollar rally.
It comes as pension funds and insurers in Asia pour into dollar assets to secure higher yields. What is emerging is a perfect storm in the currency markets, pushing the dollar through its multi-decade barriers against the euro and key baskets. This in turn risks a self-feeding spiral as technical traders and momentum funds join the chase.
Stanley Fischer, the Fed vice-chairman, said last month that a sustained rise in fiscal stimulus of one percentage point of GDP would lead to rate rises of 50 basis points under the Fed model.
This is highly significant. Goldman Sachs estimates that the Trump plan is likely to raise the US deficit by 0.75 per cent of GDP over one year, with two-thirds of the effect from tax cuts. As the policy continues it would be inflationary.
Whether the Fed will jam on the monetary brakes is far from clear. Officials are alert to the dangers of an overvalued exchange rate for US competitiveness, but they are also worried about the global financial system.
Roughly 60 per cent of the world economy is dollarised. Emerging markets are highly vulnerable to a dollar squeeze that forces them to tighten policy.
A further $US10 trillion ($13.2 trillion) of global debt is denominated in dollars outside the US, with no lender-of-last-resort behind it. This shadow dollar nexus has gone into convulsions each time the Fed has tried to tighten over the last three years, leaving it unclear whether the world can cope with serious US rate rises.
Strains are building up in emerging markets. The Mexican peso has crashed 11 per cent on fears of US tariffs. Mexico's manufacturing industry is interwoven with the US through supply chains.
But the problems are broader. The MSCI index of emerging market equities has fallen 7 per cent since the US election. The South African rand has dropped 7 per cent. The offshore rate for Chinese yuan has reached a six-year low of 6.83 against the dollar. The Achilles Heel in these countries is corporate debt, which has jumped fivefold to $US25 trillion ($33.1 trillion), and can be linked to US rates even in local currencies.
Traders sold the dollar when the first news of Mr Trump's victory began to break. Markets have since woken up to the greater risk that Republican reflation implies a much stronger dollar than anybody could have imagined just a week ago, and much stronger than the world can easily handle.
The Daily Telegraph, London
The Daily Telegraph