Dollar and Treasuries to gain on fiscal woes: James Saft

November 29, 2012

Nov 29 (Reuters) – If U.S. fiscal woes set off a market
downdraft, this time the dollar could actually be a beneficiary.

Negotiations over the “fiscal cliff,” a mix of automatic tax
rises and spending cuts, are ongoing. Though a deal of some sort
will probably be struck, there is a real chance of a
market-toxic outcome.

Stocks, of course, would suffer and Treasuries
rally, even if an inability to strike a credible
deal over the fiscal cliff makes the United States as a borrower
look, well, a bit lame.

Particularly dangerous, at least for equities, would be any
chain of events which ends with another downgrade of the U.S.
credit rating.

The lack of other credible safe havens means the dollar
should actually rally.

“When you remove the majors from safe-haven status, the
dollar has to benefit no matter where the trouble comes from,”
said Adnan Akant, head of foreign exchange at fund manager
Fischer Francis Trees & Watts.

This is quite a contrast from how assets traded the last
time around, in July and August of 2011 when the government’s
flailing attempts to reach a deal on raising the debt ceiling
led to Standard & Poor’s stripping the United States of its
hallowed AAA credit rating.

Equities fell, as expected, but government debt rallied and
the dollar got hit hard.

Treasuries received two trailing winds out of the chaos, as
they will this time if similar events unfold.

First, a cut in government spending of any sort was and will
be bad for the economy and should drive interest rates lower.

Secondly, given the lack of safe and liquid alternatives,
fund managers seeking a certain level of safety in a portfolio
almost have no choice but to add to Treasuries when the United
States itself become riskier.


No deal and draconian cuts will hurt equities as less
government spending means less revenue for companies, not to
mention the real chance of an outright recession if cuts are too
severe. It is also not wise to count on the Federal Reserve to
come to the aid of equities if we go over the cliff: Ben
Bernanke has been clear in saying there is not much he could,
much less should, do.

Which is not to say there isn’t a potential upside for
equities in the negotiations: if a moderate path of cuts is
agreed the certainty fairy may pay a visit to households and
businesses, prompting more capital investment and consumption
once the lay of the land is clear.

While it might on the surface seem an irony that the dollar
will actually benefit from U.S. fiscal disorder, a quick tour
around the other traditional safe havens reveals how few choices
investors have when it comes to calm harbors.

The other traditional safe havens, currencies that tend to
go up in times of financial distress, are hardly good
candidates. The euro can be passed over without comment.

The yen, still the beneficiary of being the currency
of a powerful creditor nation with lots of money overseas, is
more complicated. Japan’s Liberal Democratic Party is expected
to shortly regain power and has made noises about wanting more
political control over the Bank of Japan and wanting it to
engage in more radical forms of quantitative easing, both
policies which make owning the yen particularly risky around the
New Year.

The Swiss franc, also traditionally a safe haven, has
been rendered a bet on the euro by the Swiss National Bank’s
policy of capping its strength against the fragile euro
. So long as you trust the SNB to stick with the cap
under duress, and markets seem to, this robs the franc of much
of its usefulness as a safety valve.

That doesn’t mean the dollar goes up indefinitely.
Safe-haven flows are a knee-jerk reaction and, once the market
gets the measure of the medium-term outlook, things may look
considerably less safe.

The ultimate irony, and one which may eventually be bad for
U.S. assets, is that the United States’ status as leading
reserve currency, chief safe haven and strongest among the weak
will give it more latitude to delay tough decisions about its
fiscal future.

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