NEW YORK: If US fiscal woes set off a market downdraft, this time the dollar could actually be a beneficiary.
Negotiations over the “fiscal cliff,” a mix of automatic tax rises and spending cuts, are ongoing. Though a deal of some sort will probably be struck, there is a real chance of a market-toxic outcome.
Stocks of course, would suffer and Treasuries rally, even if an inability to strike a credible deal over the fiscal cliff makes the US as a borrower look, well, a bit lame.
Particularly dangerous, at least for equities, would be any chain of events which ends with another downgrade of the US credit rating. The lack of other credible safe havens means the dollar should actually rally.
“When you remove the majors from safe-haven status, the dollar has to benefit no matter where the trouble comes from,” said Adnan Akant, head of foreign exchange at fund manager Fischer Francis Trees & Watts.
This is quite a contrast from how assets traded the last time around, in July and August of 2011 when the government’s flailing attempts to reach a deal on raising the debt ceiling led to Standard & Poor’s stripping the US of its hallowed AAA credit rating. Equities fell, as expected, but government debt rallied and the dollar got hit hard.
Treasuries received two trailing winds out of the chaos, as they will this time if similar events unfold.
First, a cut in government spending of any sort was and will be bad for the economy and should drive interest rates lower.
Secondly, given the lack of safe and liquid alternatives, fund managers seeking a certain level of safety in a portfolio almost have no choice but to add to Treasuries when the US itself become riskier.
No deal and draconian cuts will hurt equities as less government spending means less revenue for companies, not to mention the real chance of an outright recession if cuts are too severe. It is also not wise to count on the Federal Reserve to come to the aid of equities if we go over the cliff: Ben Bernanke has been clear in saying there is not much he could, much less should, do.
Which is not to say there isn’t a potential upside for equities in the negotiations: if a moderate path of cuts is agreed the certainty fairy may pay a visit to households and businesses, prompting more capital investment and consumption once the lay of the land is clear.
While it might on the surface seem an irony that the dollar will actually benefit from US fiscal disorder, a quick tour around the other traditional safe havens reveals how few choices investors have when it comes to calm harbors.
The other traditional safe havens, currencies that tend to go up in times of financial distress, are hardly good candidates. The euro can be passed over without comment.
The yen, still the beneficiary of being the currency of a powerful creditor nation with lots of money overseas, is more complicated. Japan’s Liberal Democratic Party is expected to shortly regain power and has made noises about wanting more political control over the Bank of Japan and wanting it to engage in more radical forms of quantitative easing, both policies which make owning the yen particularly risky around the New Year.
The Swiss franc, also traditionally a safe haven, has been rendered a bet on the euro by the Swiss National Bank’s policy of capping its strength against the fragile euro. So long as you trust the SNB to stick with the cap under duress, and markets seem to, this robs the franc of much of its usefulness as a safety valve.
That doesn’t mean the dollar goes up indefinitely. Safe-haven flows are a knee-jerk reaction and, once the market gets the measure of the medium-term outlook, things may look considerably less safe.
The ultimate irony, and one which may eventually be bad for US assets, is that the United States’ status as leading reserve currency, chief safe haven and strongest among the weak will give it more latitude to delay tough decisions about its fiscal future.
— James Saft is a Reuters columnist. The opinions expressed are his own