Whether investors run for the hills or not after last week’s earthquake, the episode provides a glimpse of where to run for shelter – and the US dollar has risen again.
Cash has regularly provided a safe haven during times of global financial stress in the past, most recently when the coronavirus pandemic unfolded in March of last year.
Concern over a possible default by giant real estate company China Evergrande – and even fear of spillover effects on regional real estate companies, high yield debt markets and banks – cannot be ignored. – not quite on this scale.
But worries sufficiently triggered the sharp pullback in global equities this month, and the dollar was one of the few clear winners during the turmoil.
Although this market correction was widely predicted – with a majority in a recent survey of Deutsche Bank customers saying they expected a 5-10% correction by the end of the year – the plunge the MSCI All Country Index this month nearly hit 5% on Monday.
The nerves for real estate in China are far from over and financial volatility indicators are at their highest for months.
The dollar has performed impressively as a safe haven, with its main trading index gaining more than half a percent over the past week – and it has risen nearly 1% against gold, moreover by 1.4% against the pound sterling, by almost 7% against the bitcoin.
Of course, not everything is due to stress. The other big event of the past week, the Federal Reserve’s latest policy-making meeting, provides alternative fuel for the currency.
And some currency strategists are now seeing the dollar receiving a special double boost.
JPMorgan’s Paul Meggyesi and his team believe the greenback has everything to gain from both sides of the so-called “dollar smile” at the same time.
This “smile” describes the observation that the dollar tends to benefit from both extreme stress and strain to an extreme, as the heavily dollar-borrowed businesses around the world scramble for liquidity and cash. dollar liquidity; and rapid global growth and risk-taking to another, where US stocks outperform and US rates rise.
Between the two, it’s at its weakest.
“Our confidence has grown that the dollar is on the verge of a sharper breakout from either end of the dollar’s smile, or indeed both ends simultaneously,” the JPMorgan team wrote.
On the left side of the smile, they see growing angst that global growth has peaked, that political support is withdrawn, that global equities are overexploited, and that there are “growing global tail risks” coming from China. and related geopolitical fears.
On the right side are the Fed and “US rate-driven exceptionalism,” they say. Fed policymakers last week announced the start of U.S. interest rate hikes in 2022.
Support for dollar interest rates is sometimes overlooked by focusing in isolation on nominal U.S. bond yields, especially in a year like this, when the dollar has remained firm even as U.S. Treasury yields have remained firm. declined during the summer.
A better measure of dollar fortunes is often seen in relative, or inflation-adjusted, real bond yields between the United States and other major economies or regions.
After spending most of 2021 in negative territory, for example, the two-year real yield spread between the United States and Germany turned positive last month, and last week the new premium on U.S. rates hit their highest level since June 2020.
This view of the real rate makes sense for those who see inflation expectations and growth potential dominating a currency’s fortunes. All other things being equal, a tighter monetary policy today means lower inflation expectations.
Mike Dolan is a London-based columnist for Reuters.