Unusual patterns in the dollar during the latest flare-up in tensions between the US and Iran suggest that the currency may have lost its traditional role as a retreat in times of stress.

Typically, the dollar jumps, along with gold, when bouts of geopolitical nerves strike. But after the US assassination of Iranian military commander Qassem Soleimani last week the currency barely budged, judging by an index that tracks its value against a basket of other currencies. Instead, while the crisis between the two countries has abated, the dollar has climbed.

This flip in the traditional behaviour of the world’s most important reserve currency has left some market-watchers puzzled.

Richard Benson, co-chief investment officer at currency manager Millennium Global, said investors “can’t really decide” whether to treat the dollar as a haven or a risk asset. “The problem is that it can’t be both and yet this is what seems to be happening,” he said.

Analysts said that the key culprit for changing trading patterns is US interest rates, which are the highest among developed economies. That makes holding dollars an enticing proposition, as the currency offers both returns and the safety that comes with its status as the most liquid currency in the world.

That means that, in another reversal of typical roles, investors have been buying the dollar when they have been feeling upbeat, and funding that trade by selling currencies such as the euro, which have lower interest rates. When geopolitical nerves struck, “some investors had to sell the [dollar] to close out positions”, said Geoffrey Yu, the head of UK investment office at UBS Wealth Management.

The strong support for the dollar stemming from interest rates may prove to be a blip, however, and investors are still reluctant to call time on a market relationship that has held for decades. Some believe it would take a more severe geopolitical crisis for the dollar to revert to its customary role.

A more profound change to the dollar’s safe-haven status may be taking place, however, according to Zach Pandl, head of global foreign exchange strategy at Goldman Sachs. He pointed to efforts from Russia, which is expanding the use of euros and roubles for settling energy transactions, in an attempt to reduce its reliance on the US currency.

“Rising geopolitical tensions provide a flight-to-quality bid for the dollar for the private sector, but it may cause some governments to increasingly diversify away from the dollar towards the euro or the yuan,” he said.

Some central bank reserve managers have already done so, albeit at a slow pace. The latest data on global official reserves from the IMF showed a decline in dollar holdings and a pick-up in the share of the euro and renminbi in the third quarter of last year. Bank of America strategists estimated that reserve managers might have sold over $100bn of dollar-denominated reserves.

Mr Pandl said other countries could follow suit if geopolitical tensions persist. “If the tensions last just a few weeks or months, it will not be enough to get a large scale de-dollarisation effort under way,” he said. “But if it were to last a longer period or to broaden in some way, it could affect aspects of the dollar’s global role.”


Source: Financial Times