The world is awash in liquidity, and that includes central bank coffers. Using IMF’s numbers, the monthly tally of international reserves at central banks around the world shows liquidity rising by 2.5% to a record high in the 12 months through December 2005.
Where is all this central bank liquidity going? Presumably, a fair chunk of it winds up in dollars. In fact, the buck has been climbing once again, giving support to the notion that central banks continue to park reserves in the world’s lone reserve currency. The gloom that hung over the greenback in January has since lifted, with the U.S. Dollar Index rising 2.6% since the selloff on January 23.
The growing consensus that the Federal Reserve will keep raising interest rates is no doubt a factor in the renewed embrace of the dollar. The source for that prediction includes none other than Alan Greenspan, the recently retired Fed chief who’s now jumped onto the lecture circuit. According to various press reports, including the Financial Times, the maestro spoke on Tuesday at a Lehman Brothers confab, observing that the U.S. economic growth surprised the former Fed head. The implication: interest rates are headed higher.
“Apparently [Greenspan] spoke very hawkishly and suggested the market isn’t pricing in as much as they should as far as future interest-rate hikes,” John Cholakis, a currency trader at Natexis Banques Populaires in New York, told Bloomberg News yesterday.
The combination of a surfeit of liquidity looking for a home, and the prospect of higher rates in the world’s reserve currency has set the dollar bulls running again. Traders of Fed funds futures seem to agree with the thesis. The CBOT’s April 2006 Fed funds contract lends support to this view as it’s priced in anticipation of another 25-basis-point rate hike.
The Fed is increasingly worried that so much cash sloshing around raises inflationary fears. Perhaps the bond market is boarding this worry train too. The 10-year Treasury yield continues inching higher, closing yesterday at just under 4.6%, the highest since November 15. Might the bond vigilantes of yore be planning a comeback?