The dollar, with which most international trade is settled?
The yen, which benefits from the reversal of capital flows in times of uncertainty?
The Swiss franc, which has withstood financial and geopolitical crises for over a century?
Gold and bitcoin, independent of governments and in limited supply?
CHART OF THE WEEK: "Ready for gold to take-off as in 2019?"
FOREX MARKET ANALYSIS
Over the last three months, the stock markets have fallen by more than 10%. Their fall, interrupted by temporary technical rebounds, looks set to accelerate. Fundamentally, valuations are far too high in the context of an economic cycle that is stalling (see WIF, 4 September 2023). Admittedly, leading indicators are attempting to rebound. This is the case, for example, with those measuring purchasing manager's confidence. Nevertheless, they remain far below the threshold separating periods of contraction and expansion in economic activity (50 in industry, 53 in services). This means that the situation is no longer deteriorating, but that the economy will remain in recession over the coming months.
In the longer term, the outlook is no rosier. Investors have realised that rising interest rates have not yet had the worst of their recessionary impact. The tightening of monetary policy is slowly spreading throughout the economy. Governments, corporates, and households have not yet fully felt its paralysing, even suffocating effect.
Let's take the US housing market as an example. Between October 2021 and October 2023, 30-year mortgage rates, the most widely used in the United States, rose from 3.0% to 8.1% (see Fig. 2). In concrete terms, this means that monthly payments have risen from USD 1,800 to USD 3,100... or should we say "will gradually rise" from USD 1,800 to USD 3,100. There is a time lag of 12 to 24 months between the theoretical rate and the effective rate (see Fig. 3). Initially, only a tiny proportion of households are charged high mortgage interest rates. The others prefer to keep their former home rather than move, so as to keep their low-rate loans. It's only when they no longer have a choice that they are faced with this problem. There can be many reasons for this: birth, death, divorce, layoff, relocation, etc.
This example is not an isolated one. Corporations and governments will face the same problem as households: the debt burden will be so high that it will force them to spend less, whether on investment or consumption. After having drawn on their savings, they will be faced with this new financial pressure.When the defaults become too numerous or too severe, something will break in the economy.
In this risky environment, investors are looking for safe-haven assets. With bonds currently performing poorly, the adage "cash is king" is resurfacing. Yes, but which cash? In what currency? Intuitively, there are five alternatives open to investors:
▪ The US dollar, with which most international trade is settled. ▪ The Japanese yen, which benefits from the reversal of capital flows in periods of uncertainty.▪ The Swiss franc, which has withstood financial and geopolitical crises for over a century. ▪ The ounce of gold, which has a naturally limited supply. ▪ Bitcoin, whose supply is independent of governments.
Let's start with the king, the dollar, backed by the world's leading economic, commercial, financial (seeFig. 4), political and military power. It has enjoyed a special status since the Second World War, when it replaced the British pound as the international currency of reference, despite the end of the Breton WoodsAgreement in 1971, which guaranteed the convertibility of the dollar into gold. Considered a safe haven, the dollar tends to appreciate when investor sentiment deteriorates. The last two years are a perfect illustration of this phenomenon (see Fig. 5).
As long as this phenomenon persists, the dollar can be seen as a 'crisis-proof' currency in portfolios.However, this relationship is not permanent. In the long term, the greenback is more dependent on interest rates and, even more so, inflation. The Purchasing Power Parity (PPP) approach stipulates that goods and services should have a single price in all countries of the world once converted into the same currency. In practice, this means that 1 euro should be exchanged for 1.27 dollars in order to respect the inflation differential between the United States and the Eurozone (see Fig. 6). This approach, while in effective in the short term, is always a winner over the very long term. Investors should therefore bear in mind that the dollar is currently very expensive.
Still on the dollar front, an unusual phenomenon is taking place in the United States. The heavily indebtedTreasury Department is facing a wall of debt. Of the USD 6,500 billion in bonds maturing in 2023, it still has USD 4,000 billion to roll over (see Fig. 7). The credibility of the American signature is so strong that global demand for T-bills and Treasuries is very high, but this mountain of supply could end up worry ingsome investors. China, for example, is in the process of reducing its holdings of Treasuries. If, to compensate, the Federal Reserve (Fed) had to print money again to buy sovereign debt (QE), the dollar would suffer. Mathematically, if everything that is scarce is expensive, everything that is abundant will depreciate. The risk of the dollar losing all, or part of its current overvaluation is therefore very likely. Nota great situation for a safe-haven asset.
Japan has historically been a major exporter of capital to the rest of the world, particularly the UnitedStates. In times of crisis, Japanese investors tend to repatriate their capital. This sudden flow of yen purchases causes the currency to rise, as it did during the Great Financial Crisis (see Fig. 8). International investors, aware of this flight to quality, also become yen buyers, amplifying the trend. For decades, thanks to these capital flows, the yen has been regarded as a safe haven. However, by trying to control the yield curve, the Bank of Japan is issuing so many yen to buy back its own sovereign debt that it is diluting the value of its currency. Investors have realised this and are now steering clear of the yen even in a crisis.
The franc is supported by the robust fundamentals of the Swiss economy, in particular its international companies with very high added value, its low level of debt and its controlled inflation. Year after year, the Swiss National Bank ensures that movements on the foreign exchange market are not too sharp, but it allows the franc to appreciate on a trend basis. Even the collapse of Crédit Suisse in March failed to make currency traders wary. The Swiss currency has a bright future (see S&T 24 April 2023). At last, a safe-haven currency worthy of the name.
What gold and bitcoin have in common is that they are not dependent on governments and their willingness to print excessive amounts of money. Their production is limited to a predefined quantity, either physically or technically. From this point of view, the two assets are similar. In other respects, they are very different. Gold is a commodity, an asset that is accessible to everyone by nature, also used in industry, and therefore difficult to regulate. Bitcoin, on the other hand, is a decentralised but private asset, independent of governments for its creation but not for its circulation, and which has noutilitarian function other than trading. Its digital nature makes it an asset that can easily be banned by a simple political decree. Add to this the fact that it tends to be highly correlated with equities, and that its volatility is extreme, and it is easy to understand why investors prefer gold to bitcoin as a safe-haven currency.
If the price of bitcoin has soared recently, topping the $35,000 mark again (see Fig. 9), it is not because of the stock market crisis or geopolitical tensions, but because of the growing likelihood that BlackRock will end up launching a bitcoin ETF. This type of fund would make it easier for investors to access digital currencies, thereby boosting demand.
Between 2014 and 2018, and again between 2021 and 2023, the ounce of gold had to contend with rising bond yields and a strong dollar (see this Chart of the Week). In the face of these headwinds, which made holding gold unattractive to investors, its price has oscillated around a horizontal trend: USD 1,200 at the time and USD 1,800 recently. Between these two periods of "stability", in 2019 and 2020, the ounce of gold appreciated by 50%. An impressive rise. Who remembers? Savvy investors are in no hurry, as they already know that their patience will be generously rewarded as soon as interest rates fall and/or the dollar depreciates.
The bond, property and now stock market crises are prompting investors to favour cash. But not all safe-haven currencies are created equal. Gold and the Swiss franc have very solid fundamentals. The dollar a little less so. As for the yen and bitcoin, they should not be part of the discussion, given the risks they entail for investors.