This year has been a dismal one for investors as shares, bonds, Bitcoin and gold have all fallen, while inflation destroys the real value of cash. Even safe-haven currencies such as the Japanese yen and Swiss franc have taken a beating.
Yet, amid the wreckage, the mighty US dollar stands firm.
The world’s reserve currency remains the number one safe haven in a financial and geopolitical storm.
So far this year, it is up 6.76 per cent against the Swiss franc, 7.65 per cent against the euro, 8.46 per cent against the British pound and a staggering 11.17 per cent versus the yen.
This isn’t just a flash in the pan, either. Measured over a decade, the greenback is up a thumping 16.8 per cent against the euro, 23.53 per cent against the pound, and an incredible 63.2 per cent against the yen.
The dollar's strength offers some respite for international investors reeling from the crash in US shares.
The S&P 500 has fallen 18.68 per cent year to date, with the Nasdaq down 28.07 per cent, but the losses will be mitigated for those holding weaker currencies.
So, can recent US dollar outperformance continue — or is a backlash about to set in?
The US dollar is rising for three reasons, Stéphane Monier, chief investment officer at Lombard Odier Private Bank, says.
First, the war in Ukraine has driven safe-haven trade. “When things go badly, money flows into the US dollar,” he says.
The conflict has also hit the eurozone, he adds.
“We calculate it will reduce European growth by at least 1 per cent this year, against just 0.4 per cent in the US.”
Reflecting this, the euro has slumped to about $1.05 at the time of writing and Mr Monier expects it to hit parity this year.
The second cause of dollar strength is China’s growth-sapping “zero-Covid” policy, with Lombard Odier data suggesting the country’s economic activity has now fallen by a quarter on pre-pandemic levels.
Again, its currency is bearing the brunt. The Chinese renminbi has fallen about 5 per cent this year, from 6.35 to 6.68 to the dollar at the time of writing. Mr Monier expects it to slide further to around 7 this year.
“China is the world’s second-biggest economy, worth 16 per cent of global gross domestic product, so this is a significant factor in current dollar strength,” he says.
The third and biggest dollar booster is the US Federal Reserve, which is tightening monetary policy in a belated bid to recover its lost credibility after spending most of last year wrongly claiming that inflation was “transitory”.
The Fed raised the federal funds rate to a range of 0.75 per cent to 1 per cent in early May, and is expected to push through another 0.5 per cent hike at its next meeting to curb US inflation, which hit 8.3 per cent in April.
Higher US interest rates will attract foreign investors seeking higher yields on their money, further boosting dollar demand.
The Fed is also shrinking its balance sheet by about $95 billion a month, draining markets of liquidity. Loose monetary policy has been propping up global markets for years, but now the tightening has begun.
Anticipating this, Lombard Odier started the year about 12 per cent overweight the US dollar in client portfolios, but is now taking profits, Mr Monier says.
“We are still overweight [for] the dollar, but only by around 3 per cent.”
Breakneck US dollar growth looks set to ease and it could be a good time for investors to embrace risk again, he says.
“The bad news is now mostly priced into markets following this year’s sell-off. While it is impossible to time the bottom of the market, this could be a good time to start buying shares again,” Mr Monier adds.
He favours buying US equities after recent dips, with a bias towards value and high-quality stocks in the energy, defence and healthcare sectors, as well as cyber security and climate change transition.
Mr Monier would also buy tech firms, but only companies generating strong, reliable cash flows today, rather than promises of higher returns somewhere down the line.
If sentiment recovers, so could the price of industrial metals such as nickel and copper, which are vital as the world electrifies to beat global warming, while commercial real estate offers attractive yields as a hedge against inflation, Mr Monier adds.
US government bonds also look tempting as yields rocket. Ten-year US Treasury notes now yield 2.89 per cent, up two thirds from 1.73 per cent at the start of April, as bond investors anticipate Fed hikes.
Mr Monier says he “has never seen them move so quickly in such a short period” and this should quickly tame inflation.
“The interest rate on a 30-year mortgage in the US has nearly doubled in a few months, from 3 per cent to 5.55 per cent. That leaves consumers with less money to spend on other things, hitting demand and slowing the economy.”
For the US dollar to weaken, three things must go into reverse, Mr Monier says.
“The Fed tightens less aggressively, the Ukraine conflict eases and China solves its Covid issues. Predicting the future is hard, but right now, none of these look likely.”
Investors need nerves of steel to buy right now ahead of a stock market bounce, says Chris Beauchamp, chief market analyst at online trading platform IG.
“Even today’s low stock valuations cannot tempt investors, a sign of just how much the macroeconomic outlook worries everyone right now,” he adds.
Other analysts are more optimistic. 2022 has been one of the worst years on record for share and bond investors, George Lagarias, chief economist at Mazars, says, but that could reverse over the next few months.
The Fed remains “inherently dovish” and has “merely adopted the role of the hawk temporarily to preserve its credibility and mandate as an inflation fighter”, he says.
“Incredible as it may sound today, investors should start positioning for another 180-degree turn within the next few months,” Mr Lagarias says.
As soon as growth falters and inflation begins to stabilise, the Fed will declare victory and revert to form, delivering the same “soothing dovish gospel” it has preached for the past 20 years, he adds.
“Markets are already pricing in more rate hikes than most Fed members for 2022, which implies that a reversal of policy could lead oversold markets to a significant rally,” according to Mr Lagarias.
Good news for stock markets could be bad news for the dollar, which will suffer if the Fed turns dovish and slows the pace of rate hikes. Few expect a crash, though. The dollar is just too strong for that.