Following is the article titled Dollar still key safe haven asset
For long, the US dollar (and by extension US Treasuries), the Swiss franc and, among commodities, gold, have been considered key safe-haven assets during periods of financial market turmoil.
In recent times, though, the dollar had become the favourite whipping boy of those who saw the (internal and external) imbalances in the US economy as the fountainhead of all global economic problems.
Such people foresaw and have been predicting a massive dollar collapse on account of those imbalances which, in turn, would spark off a global crisis. Such a crisis, it was said, would sharply raise US interest rates, land the US economy even in a depression and lead to major economic crises elsewhere in an integrated world.
In sum, the view was that serious imbalances in the US economy would knock the dollar down so badly that it would lose its status as a safe-haven and reserve asset.
Compounding the overall bearish scenario for the dollar were the serious geo-political problems the US was grappling with in different parts of the world and the possibility of their spill-over into valuations in financial markets.
Dollar retains its pre-eminent status
Developments in the past few weeks in global financial markets, though, suggest that the dollar continues to reign supreme as a key global safe haven asset.
Ironically, in a strong rebuttal of the views of the dollar doomsayers, the reiteration of the greenback’s pre-eminent position as a provider of refuge has come about subsequent to the unravelling of serious fissures in the non-sovereign US credit markets.
That is, if the imbalances in the US economy (which includes its real and financial economies) was expected to knock the dollar off its pedestal, the fall-out has been quite the opposite.
The dollar’s position as a safe-haven asset has actually been strengthened in the past couple of months even as the problems in the US credit markets steadily worsened with every passing day.
As a consequence of the flight to safety of the dollar, key US interest rates (sovereign interest rates), have actually fallen substantially in the past few weeks. All sovereign rates are below 5 per cent currently with the benchmark 10 year yield almost half a per cent below the 5 per cent mark.
This has substantially raised the possibility of a cut in official US interest rates, even as a flight to the safety of government debt could bring in its train a credit crunch down the road.
That is, a crisis emanating from the imbalances in the US economy, instead of sinking the dollar and pushing dollar interest rates up, has, on the contrary, boosted the dollar and also raised the prospects of a reduction in US (and by extension global) interest rates.
As the Table shows, the dollar has risen against just about every other currency which form part of its major trading partners in the past two months.
Of course, the dollar has fallen quite sharply against the Japanese yen, around 12 per cent in the past couple of months. But that is due to a special, even abnormal, set of circumstances relating to the low level of interest rates in Japan.
And because of such specialness, they do not in any way detract from or weaken the overriding theme in the global financial market place today – the continued strong position of the US dollar as the first choice safe haven asset. (Indeed, the dollar’s fall against the yen has to be seen as the mirror image of the Australian dollar’s almost matching fall against the US dollar in the above period.
The Australian dollar has been a key investment destination for global carry trades borrowing in ultra-cheap yen.
And as carry-trades unwind as part of global risk aversion, there have been almost equal and opposite movements in the USD/JPY and AUD/USD currency pairs. A similar phenomenon can be observed in the case of the USD/JPY and NZD/USD pairs also).
It is also significant to note the dollar’s fairly strong performance against the Swiss franc and the US unit’s relative performance vis-À-vis gold in the above period.
The dollar is up about 2 per cent against the Swiss franc, implying that the Swiss franc has not attracted as much of the capital flows now withdrawing from risky assets/markets globally.
Gold, in the past couple of months, is up around 3 per cent at $660. It has not attracted any special safe haven flows in the midst of the market turmoil and global reports point only to the normal seasonal demand (mainly from India) buttressing gold prices currently.
Correlations break down in crisis
Apart from reinforcing the status of the dollar, the latest global financial market crisis also has proved the point (yet again) that correlations (between different asset markets, among sub-segments in markets etc) are all vulnerable to breaking down during a period of extreme stress in the markets.
In the currency markets, for instance, the sharp strengthening of the yen against the dollar has not been matched by other Asian currencies which normally track the yen.
Most Asian currencies, including the Indian rupee, instead, have fallen quite notably against the dollar.
This break-down of correlations has significant implications in the area of risk management, both for market regulators and other market participants.
An Indian company, for instance, which has borrowed yen, either directly or synthetically through currency swaps, may find that the market value of its (currency) position could actually be quite negative at the current juncture.
That is, if it had taken a strategic currency position based on a historical relationship between the movements in the dollar/yen and dollar/rupee currency pairs, it may find that the historical relationship breaks down quite seriously during market crises.
This is something companies should factor into their overall currency risk management strategy.
The future
To be sure, the dollar’s relatively impressive performance amid serious problems in the US domestic economy, does not mean that the US currency is free of vulnerabilities for all time to come. The latest developments only reiterate that it is not that easy to dislodge the dollar from its pre-eminent global position.
A key economic statistic will underline this point. The US is the only country which has almost all its external trade (both exports and imports — 100 per cent and 93 per cent respectively) invoiced in its home currency. Such is the demand for the dollar and the US markets.
2 comments:
The dollar, as predicted is being crushed. We are now at Par with the Canadian Dollar, the Loonie as it is called. This was all so predictable. You cannot run an 800 bilion dollar trade deficit and have your currency in demand. We have a lot farther to fall. Within 5 years from 2008 we should see the Canadian Dollar worth 25 % more than the U.S. dollar. The Euro at 1.40 now, should move to near 2.50, as China buys more and more of the Euro.
The pound at 2.04 as I write this will be near 3.00. Be ready for CHINA. When they finally let their currency float it will appreciate 70% over a 36 month period. The US trade deficit will be cut in half and then some by 2020.
The economic logic confirms with what you said however market has not responded in the way it should.
I would like to differ on China changing their currency regime in near future, because they need to overhaul their internal financial infrastructure which will take at least 3-4 years. So at least in near future renminbi (RMB) may not appreciate against dollar
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