Return Of The King

The dollar is back. Or at least it was for a week.

A steadily declining greenback was a fixture of the post-March surge in risk assets. Tales of king dollar’s demise pervaded the thick, virus-laden summer air.

As US real yields plunged deeper into negative territory, sentiment around the world’s reserve currency deteriorated steadily. America’s ballooning deficit and bungled COVID containment effort just added to the malaise. By mid-August, hedge funds were net bearish for the first time in more than two years (note that the figure is a snapshot as things stood on August 19).

Fast forward to the end of September and the dollar is looking to defy its multiplying detractors.

One lesson relearned in March (and I repeat this whenever the opportunity presents itself) is that when push comes to absolute shove, there is only one true safe haven — the dollar. On the back of squeezed shorts, Brexit uncertainty, a COVID resurgence in Europe, and, ironically, jitters about the US election, the greenback logged its best week since early April, climbing nearly 2%.

This is not generally conducive to risk-on behavior. It means tighter financial conditions, pressure on emerging markets, and generally exerts a deflationary impulse at a time when policymakers are keen to engineer the opposite.

It comes as no surprise that gold was on pace to log its worst (or second worst) week since the March panic. Note that real yields are 17bps higher than they were at the beginning of this month.

It would not take much in the way of a backup in US reals for gold to extend losses. Too many investors believe making the case for gold is as simple as pointing to central bank largesse and large deficits. If that was the case, gold would have rallied into the stratosphere years ago.

Meanwhile, some point to the disappearance of the yen’s positive correlation with US equity volatility in making the case for the dollar as a haven.

In any event, the longer-term, structural bear case against the dollar remains intact — or at least the greenback’s many critics will invariably claim as much. Their case is, in fact, compelling. Additionally, the dollar’s resurgence may be written off by some as little more than jostling and position squaring.

It’ll be interesting (to say the least) to see how the dollar behaves in the months ahead if things do get as dicey stateside as many fear.

I’ve long argued that the biggest threat to the dollar’s reserve status is dysfunctional domestic politics, unpredictable foreign policy from The White House, and/or some acute, destabilizing development that calls into question America’s commitment to democratic norms.

At the same time, I’ve been vocal about the fact that in a pinch, there is no haven besides the dollar.

Perhaps I’m in for some cognitive dissonance come November.


Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.

4 thoughts on “Return Of The King

  1. The real yields against gold chart is a good one. Everyone should ask themselves if they believe the FED will allow yields to rise in any sustained way after they have essentially telegraphed that inflating away the debt bubble is the preferred path of “default”. I don’t see real yields rising, unless it is via deflation that they cannot control with monetary policy and they refuse to go into NIRP.

    1. I agree. I don’t see real yields rising either, unless deflation picks up as they refuse NIRP as you say. YCC. They’ll buy up whatever assets are necessary at the durations they target to keep yields at their target or below. They have trillions to work their magic with.

      Rising real yields and watch out! After a deflationary death spiral, the last thing the Fed and other central banks want is rising real yields.

  2. To avoid a personal bias I have about the dollar, a bias that says it’s got nowhere to go but down, I remind myself of the Eurodollar market and just how large it is. Sure, there are events that chisel away, like bi-lateral trading of oil in non-USD currency. But, the size of this Eurodollar market is approaching $14T. It’s gotten bigger over time. This market is used for cross-country settlement of transactions. It’s not going to go away anything but slow and over time. And there are all the foreign borrowers, corporate and sovereign, who have taken out debt denominated in USD. They have to repay in USD.

    I agree that there is no near-term possibility of the dollar losing it’s status. Sure, over time, maybe, but slowly and probably over decades. Heck, we haven’t even seen the fallout yet from all the insolvencies that are starting to happen. When people firms go under and their loans are in USD, they are going to try to grab USD. The USD could yet experience a significant increase in value before the the economic impacts of the COVID shock finish playing out.

NEWSROOM crewneck & prints