US Dollar May Find Itself as the Top FX Safe Haven and Growth Leader

02/17/2009 11:08 am EST

Focus: FOREX

While the dollar exhibited incredible volatility this past week, for the most part, the increase in price action would not come with any defined direction from the world’s most liquid currency. Instead, the majors would further carve prominent wedge formations that will ultimately demand breakouts and a decision for direction sometime soon—and that resolution may come this week.

Fundamental Outlook for US Dollar: Bullish

  • Treasury secretary Geithner and Congress pour money into the market, yet traders remain skeptical
  • Retail sales rise for the first time in seven months through January, but does one month undo such a dour trend?
  • A reminder of whose opinion truly matters to growth, consumer outlook plunges to a 28-year low

While the dollar exhibited incredible volatility this past week, for the most part, the increase in price action would not come with any defined direction from the world’s most liquid currency. Instead, the majors would further carve prominent wedge formations that will ultimately demand breakouts and a decision for direction sometime soon—and that resolution may come this week. First, we need to take a look at price action to understand the building stress behind the markets. Both EUR/USD and USD/JPY have worked their way into terminal wedges that will force the market into a decision. However, from a fundamental standpoint, these two pairs highlight very different roles for the US dollar. When measured against the euro, direction will come from a bias in growth forecasts. Far more unique among the majors, USD/JPY pits the market’s two top safe-haven currencies against each other—and long-held rules may change.

It is well known that the Japanese yen is the go-to currency for safety of funds concerns. This has been the case for more than a decade as Japan has kept its lending rates at or near zero (deriving an anti-carry interest) and the economy has floated large surpluses and savings. However, with global interest rates plunging towards zero and worldwide growth expected to hit its worst pace since WWII, investors are left to rethink where their capital is safest and where it could also generate return when conditions do turn around. For the United States’ part, there little room for yields to deflate any further (they are also near zero). More importantly, though, they are far ahead of the curve on efforts to stabilize the domestic markets and economy. Constant liquidity injections, government guarantees, critical bailouts, proposals to draw out toxic debt that is clogging the credit system, the introduction of massive stimulus plans, and endeavors to develop regulation for the long-term make for a strong foundation that few other economies can match. It is simply a matter of time before these cumulative stimuli catch up with the greenback.

The safe-haven dynamic of the world’s most liquid currency (backed by the world’s most liquid, “risk-free” asset) has been a clear driver in all of the majors outside of the yen’s purview. However, as global policy makers attempt to put out the fires and interest rates near zero, we are slowly seeing a shift away from panic and towards growth. With global interest rates quickly approaching zero and more than three months of congestion under the market’s belt, fundamental speculation is focusing on gauging the world economies’ positions on the recession curve. For those that are looking at relatively shallow and short contractions (and therefore expected to recover first), investors see the potential for return when risk has been fully exercised. The US is certainly a ways off from finding a true bottom in its own recession, but compared to Japan and the United Kingdom, its prospects look much better. Alternatively, when set against the euro zone, we are met with real debate. We will keep an eye on the round of second-tier data due this week, but the true shift in sentiment will likely be more closely linked to the efforts of the government to recharge the economy.

By John Kicklighter, currency strategist, DailyFX.com

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