BIS Warns of Potential Dollar Surge from $113 Trillion FX Swap Unwinding

The Bank for International Settlements (BIS) has cautioned that a large-scale unwinding of positions in the foreign exchange swap market, which amounts to 113 trillion dollars, could spark a rush for the U.S. dollar. This market is primarily controlled by funds and other non-bank financial institutions, which hold over 80 trillion dollars in foreign exchange swap positions. These swaps involve borrowing in dollars and committing to repay in a specified exchange rate at a later date, often held as "off-balance-sheet" short-term debt and not included in regulatory capital requirements.

Hyun Song Shin, the head of the monetary and economic department at BIS, emphasized the potential risks during a speech. He noted that if investors suddenly rush to unwind these positions, it could lead to a rapid appreciation of the U.S. dollar. Investors who hedge their positions typically hold euros or yen but still have the obligation to repay in dollars. If they need to roll over these swaps, they would have to join the competition for dollars, which could cause the dollar to surge in value.

The BIS's warning comes at a time of market volatility in the United States, where investors are already on edge. The potential for a dollar scramble underscores the interconnectedness of global financial markets and the risks that can arise from sudden shifts in investor sentiment. The BIS's analysis suggests that the current market conditions could exacerbate these risks, making it crucial for investors and regulators to remain vigilant.

Shin also pointed out that the current situation, where the U.S. stock market, bonds, and the dollar are all experiencing sell-offs, is highly unusual. It is still too early to determine whether major investors are selling U.S. assets or simply hedging their positions. However, he believes that investors are likely at least considering strategic adjustments. If investors suddenly need to unwind these positions, it could lead to a rapid appreciation of the U.S. dollar, as those holding euros or yen would need to compete for dollars to meet their repayment obligations.