The traditional status of the US dollar as a safe-haven asset is under pressure. EUR/USD bears have lost the primary drivers that fueled the euro’s sell-off between August and October: neither rising oil prices, nor widening spreads between French and German government bonds, nor the thesis of “US economic exceptionalism” are holding weight anymore. Yields on long-term US Treasuries have dropped to a five-week low amid surging demand for safe-haven assets, leaving the greenback with little room to strengthen.
Despite the recovery of Middle Eastern oil exports to pre-war levels, Brent crude is in no rush to decline. The market remains on edge due to the risk of conflict escalation involving Iran, dwindling global inventories, and rising demand from China and the US. Investors are increasingly choosing to hedge these geopolitical risks by purchasing US sovereign debt.
A classic “flight to quality” is also underway in the US equity market. Investors have become highly selective regarding the tech sector: fears of disappointing earnings reports and doubts over the return on massive capital expenditures are weighing on valuations, further pushing down Treasury yields.
The situation in Europe only compounds the picture: yields on 10-year French government bonds have hit their highest level since 2002, while the spread with German Bunds has widened to a 15-year peak. Amid the political turmoil in Paris, capital is fleeing French debt in favor of safe-haven German assets, while US investors remain anchored in their domestic Treasuries.
Demand for US sovereign debt is receiving an additional boost from the uncertainty surrounding the upcoming midterm elections in November. The current market scenario is increasingly reminiscent of 2018, when fears of a “Blue Wave” (Democrats taking control of Congress) amid Donald Trump’s policies triggered severe market turbulence. Back then, despite an initial equity market rout, stocks quickly recovered, and the Fed, under Jerome Powell, ultimately softened its hawkish rhetoric, abandoning its aggressive rate-hiking cycle.
If this historical pattern repeats, the US dollar is poised to weaken. The key trigger for the drop in Treasury yields back then was the regulator’s wait-and-see approach. If the Fed maintains this passive stance leading up to its December meeting, EUR/USD bulls will finally get a long-awaited opportunity to stage a partial recovery.
