A new report has cautioned that a vulnerable dollar could destabilize the global financial system unless US authorities intervene with a safety net.
The dollar index has plummeted 8.7% in just three months amidst President Donald Trump's escalating trade war with China, which has sent markets worldwide into a tailspin, as reported by .
S&P Global Ratings' report warns that the growing tensions between the US and its trading partners could trigger a tumultuous upheaval in the global financial system.
Central banks typically rely on currency swap agreements to maintain liquidity during times of crisis.
However, if the Federal Reserve's relationships with other central banks deteriorate, economies may be left vulnerable, as the Fed's dollar reserves are crucial for global financial stability.
The report states: "The globalisation of the financial market was underpinned by a high degree of global coordination on financial regulation, with the Basel accords a key mechanism to achieve global alignment, and on financial stability management, with the Federal Reserve's US dollar swap lines playing a central role in times of crisis."
While the report's authors consider a breakdown in relations a "remote possibility", they emphasize the importance of US authorities providing a backstop to mitigate the risks. However, they also highlighted that hundreds of financial firms reliant on external dollar funding would be "most exposed" to tightened financing.
Hedge funds have been deleveraging their assets as Treasury yields have seen a swift surge.
Banks might also question whether the Federal Reserve would be willing to act as a global safety net in any crisis under the Trump administration, according to analysts at S&P Global. This is because the global financial system relies on the economic powerhouse for support and stability.
"Given the prominence of the US dollar in the global financial system, this minimum level of coordination is hardly conceivable without a commitment from US authorities to contribute to global financial stability, for instance by providing a backstop to global needs for US dollar-denominated liquidity in the form of central bank swap lines, in case of stress."
Japan was singled out as being particularly susceptible to disruptions in dollar markets due to its significant exposure to the US. The Bank of Japan has been advising its banks not to anticipate any safety nets from the Fed.
"Short-term or bank-specific difficulties in foreign currency funding could damage the creditworthiness of affected banks," the report warned.
The unpredictability of Trump has left major banks concerned about his potential meddling with the Fed, which operates independently from the White House's executive order.
The US President launched another attack on Federal Reserve chair Jerome Powell, urging the central bank to cut interest rates. With Powell's term set to expire in May, Trump stated that "termination cannot come fast enough."
The ongoing trade tensions also pose a risk of escalating, potentially putting additional pressure on the dollar.
Furthermore, Trump has threatened to impose an extra 10% tariff on goods from major economies and even uninhabited islands, although some countries have been granted a 90-day reprieve after initially refraining from retaliation.
According to the S&P Global report, countries such as France and the Netherlands could be impacted by a deterioration in relations, as their banks rely on dollar and euro swaps to fund their exposures.
