Adding to investor concerns is data showing record new coronavirus cases in Europe and on Friday, the UK added London to its watch list of potential pandemic hot spots. That’s crimping optimism that economic growth in Europe will materially outpace that of the US.
“There’s been a clear erosion of the idea that Europe was ‘doing better’ than the US,” said Kit Juckes, chief currency strategist at Societe Generale. Consensus growth differentials have “moved in the US’s favour.”
Still, history cautions that a further advance in the greenback is far from certain. The US currency also rallied in June but quickly gave back its gains as concerns about the global economic outlook receded.
The US Federal Reserve’s lower-for-longer rates strategy is also likely to “put pressure on the dollar,” Quentin Fitzsimmons, portfolio manager at T. Rowe Price, wrote in a note.
Here’s a look at the US dollar’s advantages in retaining its status as the supreme haven currency:
While futures indicate the Fed will keep the policy rate near zero at least until the end of next year, that isn’t as dovish as the negative-rate policy adopted by the European Central Bank and the Bank of Japan.
At about 0.2 per cent, the greenback’s three-month interest rate is the highest among Group-of-10 currencies after the New Zealand dollar, according to data compiled by Bloomberg. The dollar is expected to take pole position if the Reserve Bank of New Zealand goes ahead with a plan to deploy sub-zero rates to support growth.
Lack of better alternatives
A dearth of alternatives is another factor in the dollar’s favour. Gold, which has gained almost 20 per cent since end-March to outperform the greenback, offers no yield and, in some cases, costs money for storage.
The yen is another traditional haven, but a collapse of its positive correlation with equity volatility suggests that this status is weakening.
The liquidity factor also supports the greenback. The currency’s daily average turnover is five times that of the yen’s and more than twice that of the euro, according to a report from the Bank for International Settlements in April 2019.
During the height of the coronavirus pandemic in March, a rush for the dollar triggered a spike in the greenback and a surge in its borrowing costs in foreign-exchange swap markets. That in turn prompted the Fed to boost dollar supply in cooperation with other central banks.
“There’s still a great deal of confidence in the US dollar being the go-to currency when markets become very volatile,” said Tai Hui, chief Asia market strategist at JPMorgan Asset Management. “A lot of investors are just being ready for a period of increased volatility which drives the dollar stronger.”