By DAVE KANSAS
In times of geopolitical> crisis, the dollar has historically benefited. But as turmoil has spread across the Middle East and North Africa, the dollar has not gained ground, raising questions about its traditional role as a haven in times of uncertainty.
The poor performance of the dollar stands in contrast to other safety zones --such as Treasurys, gold and, in the case of oil-region unrest, oil which have held up well. The question arises: Is the dollar no longer a "safe" place or are other issues overpowering the greenback's usual usually cozy attraction in times of unrest? The answer, it seems, is a bit of both. But for backers of King Dollar, this surprising weakness against the backdrop of scary headlines is unnerving.
The buck began the year at about $1.30 against the euro and had fallen to about $1.35 when the Egyptian President Hosni Mubarak resigned. As the unrest spread across the region and became more violent, notably in Libya, the dollar didn't rally, but instead continued to weaken. It is now at about $1.40 against the euro. A similar, albeit smaller-scale trend, affected the dollar-yen relationship.
Meanwhile, other safe havens acted as they usually do. Gold shot to a record above $1440 an ounce, from $1360 an ounce after Mubarak resigned. Silver, so-called poor man's gold, also shot higher, rising to $36.70 an ounce from about $36.14 an ounce.
Treasurys, widely expected to retreat this year as the economy gains traction, also rallied, pushing the yield, which moves in the opposite direction of a bond's price, down to 3.49% today from 3.62% in the wake of Mubarak's resignation. Oil, at $85 a barrel when Mubarak stepped down, jumped to $105.45 a barrel.
Underscoring the nervousness in global markets, developed-market equity funds have booked inflows of more than $52 billion this year, according to fund tracker EPFR. At the same time, investors have yanked about $21 billion out of emerging markets equity funds.
But even that preference for developed markets has not helped the dollar. As the dollar swooned during the Middle East and North Africa (MENA) crisis, J.P. Morgan observed that the dollar "is not following the usual script." For investors, geopolitical uncertainty was giving way to political realities in the developed world.
The political realities in the U.S. underscore the greenback's more fragile standing in world affairs. As global leaders talk openly about replacing the dollar as the reserve currency, political actions in the U.S. are undermining the buck as an investment. In addition, the divergence between policies of the Federal Reserve and the European Central Bank is becoming more stark, further pressuring the dollar.
In the U.S., fear of a government shutdown and wrangling over the budget and debt ceiling have overwhelmed the dollar's usual flight-to-quality status. Bank of America Merrill Lynch says the Washington bickering could weigh on the dollar "for an unexpectedly long time" if Congress maintains its current stance of passing short continuing budget resolutions.
J.P. Morgan notes that in the 1990s government shutdown, the dollar lost 3%-to-7% before the actual closing. "A shutdown this year isn't preordained, but this issue justifies avoiding the dollar even as the MENA crisis persists."
More fundamentally, the short-term-interest-rate picture is moving decisively against the dollar. While the ECB and the Fed have maintained record short-term rates since the financial crisis, the ECB last week clearly signaled it intends to start raising rates soon. Currency speculators tend to favor regions where they get paid (short-term rates) better.
While the ECB has ratcheted up the rhetoric, the betting in the U.S. has gone the other direction. The Fed Funds futures markets indicate a 60% probability that the Fed will lift short-term rates to 0.5% next February. As recently as last Thursday, the bet had been nearly 100% for such a rate move.
One reason that Fed Funds futures are dialing back expectations for a rate hike early next year is the spike in energy prices. The fear is that this will undercut the recovery, prompting the Fed to remain extremely dovish for a longer period than previously anticipated.
And the market has little faith that the dollar will quickly regain the upper hand. According to RBC Capital Markets research, dollar short contracts are at 281,000 on March 1, a record level and up from 200,000 short contracts on Feb. 22. RBC thinks that barring "an absolutely stunning reversal in sentiment" short contracts are heading toward 300,000.
Of course, stunning reversals are always possible. But, at least for now, the buck looks mighty beleaguered.
Dave Kansas blogs at The Wall Street Journal's MarketBeat.