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The current financial market environment is one where market players are shunning riskier assets and moving to the safety of cash.

Increasing nervousness about economic growth, inflation concerns, geopolitical issues, and the rising interest rates has caused the switch.

The US dollar has emerged as the clear winner in this flight to safety, with the dollar index testing the highest level since 2002. Safe-haven buying, coupled with expectations that Fed may lead other central banks in monetary tightening is pushing the rupee to record highs.

Traditionally, the US dollar, bonds, Japanese Yen, Swiss France, and gold are all considered safe havens. The sharp rise in the US dollar index is clear evidence that it is seen as the preferred safe haven in the current market scenario.

Other safe havens also saw some demand this week. The Japanese yen appreciated against the US dollar, recovering from the 2002 low set earlier this month.

Lower bond prices also attracted investor interest. The US 10-year bond yield jumped to the 2018 high of near 3.2% earlier this week but retreated to trade near 2.88% reflecting buying interest in bonds.

Gold has, however, failed to attract buyers yet. Gold slumped to a 3-month low and ended the week with a 3.5% decline and is now near the key $1800/oz level.

With the recent fall, gold is nearly 12% lower than the highs set in early March this year in response to Russia’s invasion of Ukraine. In comparison, the Reuters CRB commodities index has corrected nearly 6% from the 2012 high set last month.

As against this, the MRCI World equity index has fallen nearly 20% from the highs set in January.

If we look at the trend in the last few months, the US dollar index has been on a rise since June last year and despite this, gold has managed to gain as inflation concerns, geopolitical tensions, and investor buying outweighed gains in the greenback.

Gold has come under pressure as the pace of gains in the US dollar has intensified with increasing expectations that Fed may raise interest rates aggressively to get inflation under control.

Inflation data released this week showed that growth in consumer and producer prices slowed last month, however, with no clear signs of inflation peaking, market expectations strengthened that the Fed may continue to raise rates at an aggressive pace.

Fed officials, including Fed Chairman Jerome Powell, maintained that rate hikes may continue at a similar pace but market players are still nervous that bigger moves could be considered.

Since gold has behaved more like a commodity lately than a safe-haven asset and is largely taking cues from trends in the US dollar, we may see some recovery in the metal only once the currency sees a sizeable correction.

So the question is what could trigger a correction in the US dollar? Fed remains intent on getting inflation under control so it may not change its monetary policy stance despite some weak economic numbers. Fed officials may also maintain the possibility of more hikes in the coming months.

We may see some correction in the US dollar if the risk sentiment stabilizes. Currently, market players are nervous about the health of the Chinese economy as adherence to the zero-tolerance COVID policy is hampering economic activity.

China in all possibility may continue with its COVID policy but the market reaction may subside if we see some improvement in the virus situation.

The outlook for the Chinese economy may also improve if the government takes concrete support measures. China’s inflation and retail sales data due coming Monday will be watched for more clarity about the health of the economy.

The US currency may come off the highs also if other central banks act to support their respective currencies. A weaker currency makes imports expensive which may lead to additional inflationary pressure.

We have already seen some central banks working to stabilize their currencies. Based on news reports, the Hong Kong Monetary Authority stepped into the currency markets for the first time in 18 months to stop the local currency from weakening and breaking its peg to the US dollar.

This week, Czech National Bank stepped in to pull the crown off a two-month low. A drop was seen in forex exchange reserves in countries like India, and Taiwan which indicate that measures are taken to support the domestic currency. Japan has repeatedly warned about sharp moves in the Japanese Yen.

(The author is Associate Vice President – Commodity Research at Kotak Securities.)

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