When the US was downgraded from AAA to AA+ by Standard and Poor's last summer, many believed that the safe haven status enjoyed by the dollar was coming to an end. This proved not to be.
A look at the US 10-year Treasury indicates that level of demand – the yield, which falls when the price rises, declined from 3.34 per cent a year ago to its current level below 2 per cent. With the Fed pledging to keep interest rates near zero till the end of 2014, this also impacts the long-term yields via the purchase of bonds under Operation Twist.
The Eurozone had a torrid 2011 and yet the euro-dollar exchange rate pretty much ended the year around the same level as it began.
If one considers the dollar index as a key metric – the main component of which is the euro – then the euro’s difficulty is the dollar’s gain. The recent high at $1.5690 was a test of the resistance area around previous highs, so the outlook is for a move to the downside off of this level.
Buy dollars and you’ll be wearing diamonds, as I have often been told by currency traders. Given the rally in commodities and equities over the last few months, their timing may have been slightly out but they finally look like they are coming good. In order to understand the current appeal of the dollar, it’s important to take a look back as to just why it fell out of favour. Firstly, gold has been the safe haven asset of choice. But with the precious metal looking increasingly overbought, the risk versus reward doesn’t quite appeal at current levels. Secondly, after two rounds of quantitative easing from the Federal Reserve, the dollar has been decimated. But as the US economy shows signs of improvement, it’s looking increasingly unlikely the Fed will embark on another round of QE. In an increasingly precarious economic environment, the greenback simply looks like the best of a bad bunch.
After a euphoric start to the year, March has so far been a month for pause and reflection. The rally in equities that we have seen has been one of relief rather than direction and this has been down to the successful “buying of time” operation that the ECB has performed via the trillion euro LTRO operations.
The relief that 2012 has not started with a collapse of Greece leading on to uncontrollable systemic risk in the financial markets has boosted confidence and led to risk aggression – weakening the US dollar and allowing euro-dollar to rally.
Has the LTRO solved Europe’s deep-rooted problems? No, but it has been successful in buying time. However, the market is quick to realise that this money needs to be paid back and that governments have years of austerity in front of them. We are not out of the woods, and until then you are better off with a US dollar in your pocket.
The markets were in defensive mode yesterday, and when it comes to a sell off of risk assets then the US dollar usually benefits. Yesterday was no exception as concerns over the European state of affairs continued to mount – when this is combined with the increasing rhetoric from the Fed that stimulus is coming to an end, it only means one direction for the dollar, which is upwards. The dollar has always been considered the safe haven asset of all safe havens. While it has suffered a serious depreciation in the past few years due to the Fed’s program of considerable monetary easing, the recent bout of strength has served to remind us that it’s not gold that’s the real protective asset to pile your money into during times of uncertainty, but the dollar. You may not be getting much bang for your buck if you buy US Treasuries at the moment but the prospect of actually getting your money back from the US government is a lot greater than if you were to lend it to a European peripheral state.