Investors have followed a playbook during the recent bout of pandemic-related market volatility. When major indexes are tumbling, jettison airlines, energy stocks and anything else associated with a return to normal. For safety, buy technology heavyweights that can withstand more lockdowns.
But some observers have discovered that at least one typical response to volatility has gone missing: the U.S. dollar’s reputation for being a haven in times of trouble.
The U.S. dollar tends to rise against other currencies, including the Canadian dollar, when investors are recoiling from risk, and it tends to fall when risk appetite is strong and investors are piling into commodities and emerging markets.
This relationship has been largely absent this week, though, as the new COVID-19 variant of concern Omicron causes tremendous market gyrations. But what’s more, the relationship between risk and the dollar has been absent for some time.
Over the past three months, “one observation stands out – the U.S. dollar’s status as a safe haven in G10 is gone,” Adam Cole, chief currency strategist at RBC Dominion Securities, said in a note.
Against the Canadian dollar, the greenback has remained within a relatively tight band over the past week, trading between about $1.27 and $1.28, even as stocks and commodities have swung wildly. Against the yen and the euro, it has actually depreciated.
The U.S. dollar index, which compares the dollar to a basket of currencies, was down slightly over the past week. This sideways drift might look odd given the dollar’s status during volatility.
On Friday, the Dow Jones Industrial Average fell more than 900 points, or 2.5 per cent, marking the U.S. blue-chip index’s worst decline of the year. On the same day, the price of West Texas Intermediate, the North American crude oil benchmark, fell 13 per cent to US$68.15 a barrel. Both are often associated with a flight to the U.S. dollar.
After falling again on Wednesday, stocks are well off their highs as investors await clarity on whether the Omicron variant will deal a serious setback in efforts to control the pandemic and fully reopen the global economy. The CBOE Volatility Index – or VIX, which reflects volatility expectations – has risen to about 27, up from about 15 at the start of November and near the highest level since March.
During this period of volatility, investors have rushed into bonds as haven investments, driving prices higher and pushing down yields. But the U.S. dollar has not enjoyed the same level of interest from investors looking for safety from market turmoil.
Jonas Goltermann, senior markets economist at Capital Economics, pointed out that this muted reaction resembled what happened near the start of the pandemic: In early 2020, the U.S. dollar fell against the euro and the yen amid expectations that the Federal Reserve would slash interest rates to support the economy (European and Japanese rates were already very low). While the Fed did cut rates, the U.S. dollar soared as investors panicked.
But some observers, including Mr. Goltermann, expect that today’s situation is very different. Each new wave of COVID-19 infections is having a smaller economic impact, lessening the potential shock from the Omicron variant. As well, Fed chairman Jerome Powell made it clear this week that the central bank is focused on tightening monetary conditions in light of rising inflation, suggesting that a runup in the value of the dollar owing to panic buying is unlikely.
Shahab Jalinoos, chief FX strategist at Credit Suisse, expects that a lot will depend on whether equity markets remain unstable through the end of the year – but don’t expect the U.S. dollar to emerge as a key defensive play if volatility persists.
“My guess is that if we see more volatility, we’ll see these defensive currencies like the yen and the Swiss franc continue to outperform,” Mr. Jalinoos said in an interview.
He added that the Canadian dollar, widely viewed as a riskier currency because of its perceived exposure to commodities such as oil, could struggle in this environment.
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David Berman