US dollar now sole safe haven currency

The US dollar will increasingly benefit from the flight to quality as the appeal of other ‘safe haven’ currencies wanes, according to Jack McIntyre, portfolio manager at Brandywine Global, a subsidiary of Legg Mason.

McIntyre says Brandywine Global, which manages $31bn* in fixed income assets, currently has an overweight position to the US dollar, preferring it to other perceived havens such as the Japanese yen and Swiss franc.

“Our overweight to the US dollar is a tactical position,” he says. “We know the US has some fundamental problems and we’re not sure if the country has the political will to solve these right now. However, when the global markets are in “risk off” mode the US dollar is going to be a beneficiary of the flight to quality trade – as will the yen - but there is more of a question mark as to whether Japan will be forced to intervene again. The last thing Japan needs is a strong currency; it is already making the cost of doing business in that country prohibitive.”

Given the Swiss National Bank’s recent move to cap the franc’s rise against the euro, McIntyre also doubts whether the Swiss unit will continue to benefit from safe-haven flows. “As a result of the threat of further interventions by the SNB we think the US dollar, by default, will benefit in periods of market stress” he says.

While Operation Twist might not be supportive of the dollar as such, it won’t put pressure on it, which is what we have seen with other types of monetary stimulus.

Jack McIntyre

A key threat to this scenario would come from more quantitative easing in the US, which would push down the value of the dollar. But McIntyre says he is unconcerned about the potential for more QE, believing the next round will differ in approach from the previous two.

“Operation Twist, for instance, takes the proceeds from the front end of the yield curve to buy long-dated bonds – something that will be good for the long curve. While it might not be supportive of the dollar as such, it won’t put pressure on it, which is what we have seen with other types of monetary stimulus.”

While QE environments are bearish for the dollar, they have not been particularly helpful for Treasury bonds either, McIntyre points out. “It’s counter-intuitive because you think that the Fed buying US Treasuries would be supportive of bonds, but in that environment they did not do well,” he says. “Only when the markets saw the end of QE coming did it become a good environment for Treasuries. Non-QE periods have clearly been better for bonds over the past three years.”

Nonetheless, with the US economy struggling to make headway and budget deficit reduction measures in the offing, McIntyre says he does expect the Fed to be vigilant in combating the threat of deflation. “This decreases the odds that the US will go the same way as Japan because the Fed has learned from the mistakes that Japan has made in the past” he says.

“We know the US is going to be cutting spending and raising taxes. That ultimately can be deflationary and I would expect the Fed to do whatever it takes to make sure there is no deflationary pressure ingrained in the US economy. We have managed our global bond portfolios with an overweight exposure to US Treasury duration for much of 2011 which has helped performance. However, with it appearing more and more likely that the US will avoid a recession and with the potential that Europe will avoid repeating a “Lehman” type of risk event, we have recently been reducing our exposure to high quality bonds in our portfolios.”