THE dollar is at a cross roads. At the peak of the financial crisis it was firmly in the set of “safe haven” currencies and was bought in favour of the euro, the pound and most emerging market currencies. However, as threats of a double-dip recession grip the markets, the greenback has been given the cold shoulder by investors.
According to the Trim Tabs/ BarclaysHedge survey of hedge fund managers for August, 47 per cent of the 104 fund managers surveyed said they were bearish on stocks. But only 29 per cent of managers were bullish on the dollar. This is a significant shift from three months ago, when over half of the managers surveyed were bullish about the prospects for the greenback.
“It is interesting to note that the dollar missed out on the latest ‘safe-haven’ rally,”?says Peter Toogood, director of investment services at Old Broad Street Research. “The squaring of growth needs with huge fiscal and growing current account deficits provides ammunition for both bulls and bears.”
As you can see in the chart below, the dollar is 12.2 per cent undervalued relative to other G10 currencies. So why aren’t investors interested in the buck? Firstly, it’s because of the Fed and its pledge to increase monetary stimulus if economic conditions deteriorate. One might think that the Fed’s pledge to keep a double-dip recession at bay should boost the dollar. However, there is mounting evidence that investors may be anticipating a fall back into recession even with the Fed’s help. Analysts at Capital Economics, the consultancy, write that the Fed’s two-pronged plan is flawed. Keeping interest rates low and ensuring that the financial system is flush with liquidity isn’t helping the US’s main problem: demand.
“Banks are more interested in repairing their damaged balance sheets rather than aggressively expanding credit,” Capital Economics wrote in a note to clients. Meanwhile, households are busy paying off debt. While the US economy continues through this period of healing, the dollar is likely to remain on the back-foot. Whereas in the past, a Fed stimulus signalled a rallying cry for dollar bulls, this time round things could be different. Currency strategist at CMC Markets Michael Hewson says that extra stimulus would limit dollar strength as it would increase the interest rate differential with other G10 nations.
The dollar is in a precarious position. Whether it has lost its mantle as a safe haven currency remains to be seen, but further weakness against the yen and the Swiss franc – traditional safe havens – remains likely. For now the Fed holds the balance of power.