While rising tension in the Middle East and North Africa have
sent crude prices skyrocketing, as well as hurt developed market
equities, the U.S. dollar has failed to benefit from this rise in risk
aversion. This has many questioning the greenback’s status as a safe
haven.
When Israel announced that Iranian ships would travel the Suez Canal,
the EUR/USD rallied. This demonstrated that the euro is now the flight
to quality destination, according to Douglas Borthwick, managing
director at Stamford, Connecticut-based Faros Trading.
Similarly, when Egyptians were demanding the resignation of Hosni
Mubarak, the EUR/USD strengthened, then sold off after he stepped down.
The Swiss franc and Japanese yen have also acted as important safe haven
currencies recently.
Mr. Borthwick estimates that the U.S. dollar is 8% overvalued because
of the flight into the currency that came in the wake of the demise of
Lehman Brothers and Europe’s debt problems.
“The unwinding of this situation could see a significant move higher in the EUR/USD,” he said in a recent note to clients.
Adam Cole, global head of FX strategy at RBC Capital Markets,
believes the U.S. dollar’s failure to rally does not reflect a change in
its save haven status, but rather a change in the role that risk
appetite is playing in driving foreign exchange markets.
“Risk appetite is now playing second fiddle to interest rate
expectations in driving FX and it is the different reaction function of
the Fed and ECB that explains USD weakness,” he said in a recent report.
The Fed’s ongoing quantitative easing program may be adding to the
wedge between euro and U.S. dollar rate expectations. And as rate
expectations have diverged significantly, the EUR/USD has begun to track
rate expectations much more closely, Mr. Cole added.
He said pinning U.S. dollar moves to a loss of its safe haven status
overlooks the upside risks to the greenback if unrest in the Middle East
continues to spread beyond a small number of hot spots, thereby
spilling over into a deeper and more broad-based sell-off in risky
assets.
Despite market skepticism that sovereign debt issues have been
resolved, the euro has rallied so far in 2011 and held onto its gains.
This rally is driven by incentives for reserves diversification,
interest rate differentials moving in the euro’s favor, rebuilding of
long euro positions and improving global risk appetite, according to
Citigroup currency strategists Valentin Marinov and Steven Englander.
While they believe the euro is reasonably priced based on those
factors, the strategists are less sure that the result will continue to
be euro-positive. In particular, they said investors appear to be buying
the euro as a result of increasingly optimistic comments from the ECB
about the euro zone economy.
“But incoming data largely reflect November-January conditions and
probably not the conditions that would exist if there was a major oil
shock,” the Citigroup strategists wrote in a recent report. “We think
that FX investors may begin to reconsider their optimism.”
Big positives for the euro include the chronic overhang of U.S.
dollars among reserve managers globally, the perception of a bias
towards easing in U.S. monetary policy, America’s lack of credibility on
fiscal policy, and the perception that U.S. policy is oriented to
dollar weakness.
The Citigroup strategists admit that these are hefty U.S. dollar
negatives that should dominate in the long term. In the shorter term,
however, they think investors are overestimating the euro’s resilience
in the face of global supply shocks.”
Yesterday’s better-than-expected reading of Canada’s economy raised
fresh questions about the timing of the central bank’s next rate
increase, and economists wonder what the Bank of Canada governor may
signal with the decision at 9 a.m. ET.
Speculation over the central bank’s accompanying statement continued to help push up the Canadian dollar,
which was sitting this morning at more than 3 cents above parity with
its U.S. counterpart. Feeding into that as well was broad weakness in
the greenback, said Scotia Capital currency strategist Camilla Sutton.
Today’s decision isn’t about moving the benchmark overnight rate but
more about the “tone of the statement,” she said.
Here are the views of several economists in the wake of yesterday’s
report from Statistics Canada that showed the economy expanded at an
annual pace of 3.3 per cent in the fourth quarter of last year:
“Certainly, the stronger-than-expected turn out in the fourth quarter
increases the risk that the Bank of Canada moves sooner than our
anticipated July rate hike. However, we are still comfortable with our
view that the Bank of Canada will remain on hold until mid-2011 and only
move gradually with interest rates. The U.S. Federal Reserve is
anticipated to remain on hold for much of 2011, and low interest rates
in the U.S. will constrain how far the Bank of Canada can raise interest
rates in light of the implications it would have for the Canadian
dollar.”
Diana Petramala, Toronto-Dominion Bank
“With growth handily outpacing the Bank of Canada’s expectations, this
upbeat report begins to tip the balance back in favour of earlier rate
hikes. We had been looking for the bank to wait until their July meeting
before restarting the rate hike process, and are still comfortable with
that call. But, if there is a surprise to our rate call, it now looks
like the Bank would go earlier, rather than wait longer.”
Douglas Porter, BMO Nesbitt Burns
“We continue to expect that the [Bank of Canada] will remain on hold at
[today’s] monetary policy meeting. However, the key will be the
characterization of domestic growth in the communiqué. Given growth in
the fourth quarter and the positive revision to [the third quarter], the
[Bank of Canada] may sound less dovish than at the January meeting. We
continue to think that the [Bank of Canada] will hike rates at the May
meeting.”
Charles St-Arnaud, Nomura Securities
“If the bank was preparing for tightening, it would likely be shifting
its bias toward being more hawkish, whereas the tone of its
communications has softened in recent months. In fact, we continue to
think the absence of inflation pressures in Canada combined with a mixed
growth picture will keep the [Bank of Canada] on hold until October.
Derek Holt and Gorica Djeric, Scotia Capital
