Tags: dollar | euro | greenback | Treasury

Has the Dollar Lost Its Safe-Haven Status?

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Tuesday, 29 Apr 2014 02:13 PM Current | Bio | Archive

The greenback isn't what it used to be. At least for now, when there's a "flight" to U.S. Treasurys — historically a sign of "safe-haven" demand — the U.S. dollar has not only not benefited, but has increasingly been on the losing end. Is this a temporary sign of special circumstances or has the dollar lost its safe-haven appeal? There may be profound implications for investors' portfolios seeking downside protection.

Let's get right to the point. A sour mood in the markets, often referred to as a "risk-off environment," may be associated with:

• Falling stock prices;

• Rising volatility;

• Rising U.S. Treasurys; and/or

• A rising U.S. dollar.

What we tend to forget is that the next crisis is likely to be "different," even as some warnings signs may be the same. As such, many myths have developed that in practice are at best oversimplifications, and at worst may lead investors to be incorrectly positioned for the next crisis. Today, we zoom in on the relationship between the U.S. dollar and U.S. Treasurys. The chart below shows a one-year rolling correlation between the U.S. dollar index and 10-year Treasury Notes:

Merk1.jpg
To make sure everyone understands this chart:

• Treasurys are rising (bond yields falling) when there's a "flight" into Treasurys.

• The dollar index is rising when the dollar is rising versus a basket of currencies.

• A positive correlation suggests that Treasurys and the dollar move in the same direction. On the days when Treasurys are risings, the dollar index will rise as well. Similarly, when Treasurys are falling the dollar index declines. In other words, when there's a "flight" into Treasurys on a typical risk-off day, it's associated with a flight into the greenback, out of foreign assets.

• A negative correlation suggests that Treasurys and the dollar move in the opposite direction. On days when Treasurys are rising, the dollar index is falling, and when Treasurys are falling, the dollar index is rising. In other words, when there's a "flight" to safety (Treasurys are rising), it's associated with a flight out of the greenback. This could happen when domestic investors flock to the greenback, but foreigners prefer other assets.

The steep drop on the right hand side appears to suggest that the U.S. dollar is losing its safe-haven appeal. Assuming you have recovered from looking at this chart sufficiently to read on, let's take a deep breath and assess what this means. A couple of thoughts:

• The dollar "always" benefiting in times of crises — or at least when such crises are expressed in terms of U.S. Treasurys benefiting — is a myth.

• The myth of a risk-off trade benefiting the U.S. dollar was reinforced in the aftermath of the financial crisis.

Looking more closely, one can't escape the surge up to the summer of 2012, then the sharp selloff of late. A couple of thoughts:

• The mundane: we are measuring one-year rolling correlation. Some event caused the correlation to surge. Conversely, of late, that event is no longer part of the data set.

• The non-crisis crisis: Treasurys haven't been all that volatile of late. Striking still is that rather than moving toward a correlation of near zero (showing that there is no correlation), the correlation has plunged deeply into negative territory. It's possible that the greenback only benefits during a "real" crisis. Possibly in "subtle" crises, the greenback is not favored by investors.

• The real deal: the dollar index has a 56 percent euro weighting. It was in the summer of 2012 that Mario Draghi, the head of the European Central Bank, announced he would do "whatever it takes" to save the euro. At the time we published an analysis entitled "Draghi's Genius" discussing what we said would be a turning point in the eurozone debt crisis. And boy it has. The little flare-up in the chart above in early 2013, by the way, is the crisis in Cyprus. Despite some jitters in the markets (that's the flare-up in the chart), there was no longer the so-called "contagion," as risk was priced locally (please click here for a full analysis published at the time titled "Chaos Investing Unplugged"). The chart above suggests the euro has become a true competitor to the greenback — at least for now.

It's possible that this reversal of fortune for the greenback is temporary. It may also be the proverbial canary in a coalmine — you can't rely on the greenback any longer as the one "safe" place.

Indeed, we have long argued that there may not be such a thing anymore as a safe asset, and investors might want to take a diversified approach to something as mundane as cash. This chart appears to support this notion.

We manage the Merk Hard Currency Fund, the Merk Asian Currency Fund, the Merk Absolute Return Currency Fund, as well as the Merk Currency Enhanced U.S. Equity Fund.

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard money, macro trends and international investing. He is considered an authority on currencies.

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The greenback isn't what it used to be. At least for now, when there's a "flight" to U.S. Treasurys — historically a sign of "safe-haven" demand — the U.S. dollar has not only not benefited, but has increasingly been on the losing end.
dollar, euro, greenback, Treasury
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2014-13-29
Tuesday, 29 Apr 2014 02:13 PM
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