Hopes for an expansion of the European Financial Stability Fund, and the financial rescue vehicle's ability to avert a euro zone debt crisis, have seen investors putting some investment risk back on the table since Monday.
But if sentiment were to turn negative, as it was at the end of the last week, there is only one place for foreign exchange investors to hide, according to David Bloom, the head of foreign exchange strategy at HSBC.
“Last week’s gloomy outlook for global growth from the (Federal Open Market Committee), the (International Monetary Fund), and the World Bank has caused an exodus from risk assets such as equities and commodities,” said Bloom. “The main beneficiary of this repositioning has been the US dollar."
This flight to the dollar comes despite the huge structural problems facing the United States, which has the world’s largest national debt and a huge trade deficit with China.
“The only reason that the dollar has benefited is that no alternative safe haven exists. The other traditional safe havens – the Japanese yen and the Swiss franc – have been taken out of play by official Japanese and Swiss intervention to halt their appreciation,” said Bloom.
Other nations with safe haven characteristics simply do not have sufficient liquidity to absorb safe-haven flows, according to Bloom.
“Although we have argued that the Norwegian krone has many of the desirable features of a safe-haven, it has limited liquidity and so significant flows are likely to make it appreciate aggressively, causing the authorities to intervene,” said Bloom. “Despite the US’s continued structural problems, demand for the USD has increased because there is simply nowhere else to hide.”
When things turn, as they may have done on Monday, the dollar will in Bloom’s opinion trade lower as investors decide it is time to try riskier trades.