Chart of the Week: Dollar Remains Safe Haven of Choice Amidst Volatility
The United States may be wrestling with a wide array of economic problems, ranging from subpar economic growth to a new uptick in the unemployment rate. But for many investors, dollar-denominated assets are overwhelmingly the “safe haven” asset of choice, to a far greater extent than has been the case in the last several decades.
That is clearly displayed in this week’s Chart of the Week, below, which plots the relationship between the value of the U.S. dollar (as measured by the DXY index) and market volatility levels (as measured by the VIX, a Chicago Board Options Exchange measure created to capture the volatility of options on the S&P 500 index.) (The correlation is calculated based on the 90-day rolling correlation of the percentage change.) As equity markets became more volatile and began to lose ground in April, the correlation between the two took another big upward jump, signaling that while investors were prepared to flee risk assets, they weren’t prepared to dump Treasury bonds and other dollar-denominated holdings for those valued in more volatile or less liquid currencies.
That apparent investor conviction that the dollar itself is a safe haven may account for at least some of the feverish buying of Treasury securities in recent days that has pushed yields on the bellwether 10-year note below 1.5%.
Of course, equity investors may well look askance at this mania for safety. If the dollar is viewed as safer than other currencies, then shouldn’t U.S. stocks carry a slightly less outsize equity risk premium? As we noted in the May 2012 review charts, globally, the equity risk premium is now more than double its historic average of just under 4%. That gap is slightly smaller in the United States than it is globally – but the gap between the earnings yield on the S&P 500 index and the real bond yield is creeping northward once more as the equity risk premium has soared to 9.2%. That’s still lower than it was at the height of the financial crisis, or last summer, the last occasion on which the eurozone appeared to approach the brink of catastrophe, but it’s dismayingly high. With corporate profits now approaching 10% of GDP, it appears downright irrational. Of course, those profits are being carefully squirreled away on balance sheets, or paid out in dividends, to a far greater extent than has been true in the recent past. Perhaps CEOs and CFOs, too, have been affected by the “risk off” mindset.