MNI INTERVIEW: Dollar Safe Haven Status Tarnished -ICMA's Hill

The sell-off in the U.S. dollar over the past few weeks is raising questions about the currency’s safe haven status and putting focus on the U.S. Treasury market, International Capital Market Association Managing Director Andy Hill told MNI.

“There’s been a three-percent selloff in the dollar in the last few weeks. It is beginning to feel a little tarnished as a safe haven,” Hill said in an interview.

“Longer term, I think we need to worry a little bit about the erosion of the U.S. dollar as a safe haven. I can see a risk of this becoming a trend, I really could,” he said, noting that for the moment markets lack an obvious alternative to U.S. Treasuries as a safe haven.

The Bund market is too small and euro safe asset will remain a distant prospect while EU-level joint borrowing remains so constrained, he said.

If President Donald Trump were to follow up on criticism of Fed Chair Jerome Powell by firing him it could jeopardise the dollar’s status as the world’s global reserve currency overnight, Hill said. (See MNI INTERVIEW: Fed Independence Facing Imminent Risk - Menand)

“I am not sure I would sleep so well with a non-independent Fed as this could compromise the U.S. as a safe haven.” (See MNI INTERVIEW: Independent Fed Key To Inflation Fight-Raskin)

T-BOND SELLOFF

In terms of the immediate trigger for the recent U.S. bond sell-off, Hill attributes hedge funds unwinding leveraged swap trades as a possible exacerbating factor, more so than the often cited “basis trade”.

“I think that is what happened. If you look at what happened to swap spreads during the tariff tantrum, government bonds got cheaper to swaps and that was probably hedge funds getting squeezed out as the market moved against them. I think that that is far more significant than the basis trade. The swap trade drove a lot of that move.”

Hill pinpoints macro- as well as micro-level concerns combining to potentially destabilise the U.S. Treasury market. The former includes the five-fold increase in US government debt to its current total of $29 trillion since pre-global financial crisis days. Adding to that are recession and inflation fears off the back of the tariffs.

“That’s not a good mix for Treasuries. One starts to worry about the credibility and sustainability of the Treasury market, which is predicted only to increase over time, with tax cuts coming too presumably.”

Any sign that sovereign wealth funds and the world’s central banks are tired of holding their USD8.5-trillion share of the U.S. Treasury market would set alarm bells ringing, but so far there is little sign of that.

“Everything suggests that that hasn’t happened to any great degree,” Hill said. 

Among other risks to keep an eye on is the blow out in high-yield credit spreads.

“I don’t see systemic risks there being huge but it’s definitely one to keep an eye on,” he said.

Potentially exacerbating threats to financial stability is the way in which long-term growth in government debt has outpaced market maker capacity.

“Bond markets continue to grow compared to primary dealer balance sheets and that equation just does not add up any longer,” said Hill.