COLUMN-Dollar smiling from ear to ear – Mike Dolan
Band Mike Dolan
LONDON, September 22 (Reuters) – Whether investors run for the hills or not after last week’s earthquake, the episode provides a glimpse of where to run for shelter – and the US dollar has prevailed.
Dollar cash has regularly provided a safe haven during times of global financial stress in the past – most recently, when the coronavirus pandemic unfolded in March of last year.
Concern over a possible default by giant real estate company China Evergrande – and even fear of spillover effects on regional real estate companies, high yield debt markets and banks – cannot be ignored. – not quite on this scale.
But worries sufficiently triggered the sharp pullback in global equities this month, and the dollar was one of the few clear winners during the turmoil.
Although this market correction was widely predicted – with a majority in a recent survey of Deutsche Bank customers saying they expected a 5-10% correction by the end of the year – the plunge from peak to trough of the MSCI all countries index .MIWD00000PUS this month almost hit 5% on Monday.
China’s real estate nerves are far from over and financial volatility indicators are at their highest in months .VIX.
The dollar has performed impressively as a safe haven, with its main trading index gaining more than half a percent .DXY over the past week – and it’s up almost 1% against gold XAU =, more than 1.4% against sterling GBP =, almost 7% against Bitcoin BTC =.
Rival havens like the Japanese yen JPY = and the Swiss franc CHF = equaled or surpassed that in the past seven days – but the dollar is clearly independently inflated.
Of course, not everything is due to stress. The other big event of the week, the Federal Reserve’s latest policy-making meeting, provides alternative fuel for the currency.
And some monetary strategists see the dollar now receiving a special double boost.
JPMorgan’s Paul Meggyesi and his team believe the greenback has everything to gain from both sides of the so-called “dollar smile” at the same time.
This “smile” describes the observation that the dollar tends to benefit from both extreme stress and strain to an extreme – when heavily dollar-borrowed companies around the world scramble for cash and cash. dollar liquidity – and rapid global growth and risk-taking – where US stocks outperform and US rates rise. Between the two, it’s at its weakest.
“Our confidence has grown that the dollar is on the verge of a sharper breakout from either end of the dollar’s smile, or indeed both ends simultaneously,” the JPMorgan team wrote.
On the left side of the smile, they see growing angst that global growth has peaked, that political support is withdrawn, that global equities are overexploited, and that there are “growing global tail risks” from the crisis. China and related geopolitical fears.
On the right side are the Fed and “US rate-driven exceptionalism,” they say. Fed policymakers this week are likely to signal the start of U.S. interest rate hikes from late next year and – most importantly – up to six hikes through the end of 2024.
Support for dollar interest rates is sometimes overlooked by focusing in isolation on nominal U.S. bond yields – especially in a year like this, when the dollar has remained firm even as U.S. Treasury yields have declined during the summer.
A better measure of dollar fortunes is often seen in relative, or inflation-adjusted, real bond yields between the United States and other major economies or regions.
After spending most of 2021 in negative territory, for example, the US-Germany two-year real yield spread turned positive last month, and this week the new premium on US rates reached its highest level since June 2020. Ten-year equivalent US rate premiums are also their highest since April.
This view of the real rate makes sense for those who see inflation expectations and growth potential dominating a currency’s fortunes.
All else being equal, tighter monetary policy today means lower inflation expectations, less erosion in the value of money over time, and a higher exchange rate – all assuming that the Growth potential is robust enough to support high rates and a higher “end rate” in the tightening cycle.
And that has to be compared to expectations of growth and inflation in Europe or Japan.
Matthew Hornbach and his team at Morgan Stanley are also seeing the dollar rise further due to rising real rates. And they think this week’s Fed meeting could be a big time.
“The September FOMC could be a key catalyst pushing up US (real) yields, which we hope will give the dollar a big boost,” they wrote this week.
Dollar Performance During A Stressful Weekhttps: //tmsnrt.rs/3AIdeI5
Relative real rate support for the dollar https://tmsnrt.rs/3EBIZVt
Markets shaken by Chinese risks https://tmsnrt.rs/3hWiu3d
(by Mike Dolan, Twitter: @reutersMikeD; edited by Kevin Liffey)
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.