Following up with some further observations in funding markets, the change in character of the “dollar” has shown up in some of these places. As I have noted before, the eurodollar curve gained an upward bias in shorter term “dollar” rates, and thus “tightening”, while the rest of the curve continued to flatten out. Going from August to September, that meant the same flat shape just attached to a higher point on the curve in 2017.

ABOOK Oct 2014 FOMC Eurodollars Sept 30

Between the end of August and mid-September, while the “dollar” was wreaking the most havoc globally (not just Brazil; the ruble isn’t just geopolitical), the entire curve shifted upward for late 2015 and to the new attachment in later 2017. So despite what the FOMC has loudly and strenuously stated about taper not being tightening, funding markets have enacted exactly that. That tight bias remained all the way to the end of September with, again, the curve flattening still further 2018 and out, leaving the relatively “tighter” conditions 2017 in.

That predisposition was also apparent in swaps, which showed a more determined preference in September to hedge toward higher rates (though shorter term, these are positions tied to funding conditions not longer run-maturities of actual credit positions; thus the seemingly counterintuitive bias toward both tightening and flattening).

ABOOK Oct 2014 FOMC Swap Spreads

In fact, there is a rough but evident and persistent correlation between the trade weighted dollar index and swap spreads, including the period in question. Swap spreads began to decompress in early July which coincided with the most recent dollar inflection. That gained in September as you can see above where the 5-year spread now regularly exceeds the 10-year like the months leading up to the May 2013 event, and at spreads not seen since last summer.

ABOOK Oct 2014 FOMC USD Swaps

So the contours of the gyrations in swap spreads compressing and decompressing match up with changes in the assumed “price” (meaning availability for rolling the global dollar short forward) of the US dollar.

The move, I think, has been more exaggerated this time simply because the global dollar system itself has been eroding since August 2007, with a large “kick” coming in 2013. That is, to me, the significance of what the TIC flows (though delayed) are saying about dollar participation, and really what amounts to heightened reticence about funding. These dollar “shorts” were essentially put on notice in 2013 that “something” had changed, tightening, and that was only partially obscured by various central bank actions in the meantime.

ABOOK Sept 2014 TIC Flows Long

The latest episode that traces back to July, with the more important stiffening in early September, comes during this already-heightened awareness and thus becomes more of a problem in seeming disproportionality. That renders some thought as to why the FOMC would suddenly and seemingly shift some of its course toward “dovishness.” Whether that was actually the case or not remains to be seen, but clearly the Fed has good interest in “talking down” what may be another globally harmful “dollar” event when capacity is seemingly so run down already.

ABOOK Oct 2014 FOMC Eurodollars Oct 8

Again, whether or not the Fed intended to be less assured about rate hikes, certainly given its own clear misconception on the global economy, the funding markets have taken it that way; at least in the initial knee-jerk period.

This all, I believe, highlights very well the trap to which the FOMC has always been contained. Getting in on QE and ZIRP and everything else was relatively easy, as is anything when conditions are already seemingly at their worst (like TBTF) – getting out is almost universally to be violent and disruptive. Here we see the inevitable end of QE, global tightening, that threatens to upend even more the global economy that never really responded as was intended in the first place. So the Fed must try to talk the dollar down without undercutting at the same time its own recovery narrative, since the eurodollar curve shown above is not exactly a full-throated acceptance of the robust story they are desperately trying to pitch (joining the rest of the non-corporate credit space).

In the larger schematic, this all demonstrates just how bastardized the global exchange system has become, dominated almost exclusively by finance. That and this persistent disruptive tendency serve as an apt metaphor for the economy here and abroad – all of it overrun by financial considerations rather than having finance serve far more in the background as a support mechanism for actual economic factors.