In a Risky World, the Road to Safety Leads to the U.S. Dollar
(Bloomberg) -- The need for safety in an increasingly risky world has investors betting that the dollar’s blistering rally has further to run.
The Bloomberg Dollar Index is holding near the 2021 peak it reached in March. It rallied 2.3% in June, its biggest monthly gain since March 2020, when the pandemic panic first shook risk assets, outperforming the British pound and euro, as well as traditional haven currencies the Japanese yen and Swiss franc.
The most striking aspect of the greenback’s recent climb is its jump after the FOMC’s June meeting, where the dot plot showed that with the U.S. economy heating up Fed officials expect rate hikes to come far sooner than the market anticipated, potentially as early as 2022. Then, Chairman Jerome Powell said at his press conference that the central bank started “talking about talking about” tapering. The dollar index rose 1% from June 16-18 alone.
The dollar “looks to have more room to run to the upside,” said Michael Brown, senior market analyst at London’s Caxton FX, adding that market skittishness could increase the demand.
Taking a longer view, the greenback is up 2.5% since June 1. That’s in stark contrast to the dollar index’s average monthly decline of 0.3% since the market crashed last year. In addition, investors increased their bets that the dollar would rise through the rally, potentially signaling that this momentum has legs.
All About the Fed
The dollar’s staying power all comes down to what the Fed says and does from here. Frequent appearances from the central bank’s members last month gave it a push, especially as taper talk accelerated.
“What initially started as a short dollar unwind still has legs to turn into outright long dollar positions ahead of a Fed taper announcement,” said Viraj Patel, senior strategist at Vanda Research. “We’d see this as a buy the rumor, sell the fact event -- with the USD likely selling off after the taper signal itself.”
At the moment, the dollar is moving in the opposite direction of Treasury yields. This could signal a return to last year’s popular trade, but in the opposite direction. Back then, investors pulled out of bets on the currency rising while yields gradually moved higher in anticipation of an economic reopening. This time, however, the dollar is seeing renewed interest and yields are falling.
What’s more, there’s a bullish scenario for the dollar if the Fed raises rates or signals that it plans to, as it would add to the demand for the greenback relative to other global assets with U.S. investors selling bonds.
Searching for Safety
“The stronger dollar likely has more to do with a hawkish repricing of U.S. monetary policy expectations, with a sprinkling of short-covering on top, than any explicit haven demand.” Caxton FX’s Brown said. “The latter, though, may entice further longs should market nerves persist.”
Indeed, the next leg up for the U.S. currency could stem from the hunt for safety in the FX market. Evidence of this is already appearing in G-10 currencies.
Traditional havens like the Swiss franc and Japanese yen have been leading their G-10 peers so far this month. The dollar could follow in suit as analysts see even more gain through the end of the summer with the Covid-19 delta variant spreading throughout the world. In a nod to the 2020 pandemic trade, investors are buying Treasuries, tech stocks and the dollar, signaling defensive positioning.
Meanwhile, emerging-market nations that are lagging in reopening time lines and vaccination rates face the fallout of the pandemic. From Cuba to South Africa, food shortages, blackouts and struggling economies have investors reconsidering their exposure to higher-yielding EM currencies. Since mid-June, the J.P. Morgan Emerging Market Currency Index has sunk 1%, with the latest move lower responsible for nearly half of its year-to-date drop after a powerful rally amid the reopening enthusiasm following the Pfizer vaccine announcement in November.
“There’s still some hedging for hawkish Fed-related moves ahead of Jackson Hole (the central bank’s conference next month) or the September FOMC,” Vanda’s Patel said. “Then we think the USD is the go-to haven.”
©2021 Bloomberg L.P.