THE US dollar has plunged to a 16-month low in the latest wild move for the global financial system, tightening the currency noose on the eurozone and Japan as they struggle to break out of a debt-deflation trap.
The closely watched dollar index fell below 92 for the first time since January 2015, briefly catapulting gold through $1,300 an ounce in early trading and setting off steep falls on stock markets in Asia and Europe.
The latest data from the US Commodity Futures Trading Commission show that speculative traders have switched to a net "short" position on the dollar.
This is a massive shift in sentiment since the end of last year when investors were betting heavily that the US Federal Reserve was on track for a series of rate rises, which would draw a flood of capital into US assets.
Markets have now largely discounted a rate rise in June, and are pricing in just a 68pc likelihood of any increases this year.
The dollar slide has been a lifeline for foreign borrowers with $11?trillion (pounds 7.5?trillion) of debt in US currency, notably companies in China, Brazil, Russia, South Africa, and Turkey that feasted on cheap US liquidity when the Fed spigot was open, and were then caught in a horrible squeeze when the dollar surged in 2014 and 2015.
But it increases the pain for the eurozone and Japan as their currencies rocket. The world is playing a high-stakes game of pass the parcel, with countries desperately trying to export their deflationary problems to others by nudging down exchange rates.
The Japanese yen appreciated to 105.60 yesterday, the strongest since September 2014 and a shock to exporters planning on an average of 117.50 this year. The wild moves over recent weeks have blown apart Japan's reflation strategy. Analysts from Nomura said Abenomics was now "dead in the water". The eurozone is also in jeopardy, despite enjoying a sweet spot of better growth in the first quarter. The euro touched $1.16 to the dollar early yesterday. It has risen over 7pc in trade-weighted terms since the European Central Bank (ECB) first launched quantitative easing in a disguised bid to drive down the exchange rate.
Prices fell by 0.2pc in April and deflation is becoming more deeply lodged in the eurozone economy, with no safety buffers left against an external shock. The European Commission this week slashed its inflation forecast to 0.2pc this year from 1.0pc as recently as November.
There is little that the Bank of Japan or the ECB can do to arrest this unwelcome appreciation. The Obama administration warned them at the G20 summit in February that any further use of negative interest rates would be regarded by Washington as covert devaluation, and would not be tolerated.
"These central banks have reached the limits of what they can do with monetary policy to influence their exchange rates, and this is putting their entire models at risk," said Hans Redeker, currency chief at Morgan Stanley. "Europe and Japan are operating in a Keynesian liquidity trap. We are nearing a danger point like 2012 when it could lead to an asset market sell-off. We're not there yet," he said.
Neil Mellor, from BNY Mellon, says the soaring euro is in the end self-correcting since the eurozone cannot withstand the pain for long, and as this becomes evident the currency will start sliding again.
The fate of the dollar now hinges on the Fed. Markets are betting that chairman Janet Yellen will continue to hold fire, but this could be a misjudgment. Boston Fed chief Eric Rosengren, a long-time dove, has warned twice over recent days that markets are underestimating the pace of rate rises this year.
A key reason for the Fed's retreat in March was a tightening in financial conditions - worth three rate rises in the words of Fed governor Lael Brainard - but this has since reversed. The panic over China has subsided. Commodities have begun to recover. The weaker dollar is itself a shot in the arm for the US.
Professor Tim Duy from Fed Watch said the institution is itching to return to plan with three quarter-point rate rises, preferably as soon as June, September, and December, knowing that any further delay could leave it behind the curve.
"Be forewarned. If the data shifts, they will be looking hard at June. I would not be surprised to see the doves shedding their feathers to reveal the hawk beneath," he said.
If Prof Duy is right, the dollar could come back with a vengeance, and a great number of hedge funds and speculators may be caught on the wrong side of some very large bets on currencies, bonds, and equities across the world.