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.