(Bloomberg) -- The U.S. dollar is the darling of strategists and investors again -- but this time, for reasons that go beyond America's borders.
China's economic deceleration and Covid lockdowns, Russia's move to use its natural-gas exports to retaliate against Ukraine's allies, and Japan's continued commitment to record-low interest rates have all driven other currencies to the weakest against the dollar in years, even after the greenback paired its gain Friday.
The scope of that geopolitical turmoil is reviving the dollar's status as a haven, extending gains seen earlier this year as traders shifted to the U.S. to seize on rising interest rates from the Federal Reserve. On Thursday, one gauge of the greenback pushed through to the strongest level since 2002, swept up by a wave of demand for the world's reserve currency, before the dollar snapped a seven-day rally by edging down against its peers.
“It's a perfect storm in favor of the dollar,” said Tom Fitzpatrick, the chief technical foreign exchange strategist at Citigroup Inc. “At the moment, it's the best house on a bad block.”
The dollar's rally, even in the face of surging U.S. inflation, a shaky stock market and speculation that rate hikes could set off a recession, seems to track the “dollar smile” theory developed by Stephen Jen, chief executive at Eurizon SLJ Capital Ltd.
That model predicts that the dollar will advance under two opposing scenarios: when risk aversion fuels demand for the safest assets, or when U.S. growth outperforms the rest of the world. Huw Roberts, head of analytics at Quant Insight, said it's the haven side of the equation that's driving it now.
“Markets are worried and looking for safe havens,” he said.
This month, the U.S. dollar has advanced against all of its major counterparts, most notably the yen, which hit a 20-year low against the greenback Thursday. The ICE U.S. Dollar Index also climbed to a two-decade high, while Bloomberg's dollar index is headed for its biggest monthly gain since 2012.
Not everyone is convinced the gains will be sustained much longer. Aaron Hurd, senior portfolio manager at State Street Global Advisors, is waiting for an “inflection point” as soon as May or June, in part due to the expected move by the Fed to start pulling support from the U.S. bond market by not buying new securities when old ones mature.
“It's more interesting to just kind of wait for when to sell,” he said. “I think of this as the final stages -- as the topping phase -- of the dollar bull market, which technically started around July 2011.”
The dollar retreated against most major counterparts on Friday, including the Australian dollar, the yen and the euro, after an unexpectedly large jump in employment costs during the first quarter of the year heightened concerns about inflation. Even so, the Bloomberg dollar index is up about 1.5% this week.
The pendulum could swing the other way if the U.S. economy stumbles under the weight of rising interest rates. That could prevent any relative economic-growth advantage that could fuel the dollar's gain against others if haven-based demand wanes.
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Economists surveyed by Bloomberg see U.S. real GDP growth moderating 2.5 percentage points to 3.2% this year, compared with a 2.8% estimate for the euro area. China's growth is also expected to slow markedly from the rapid pace seen previously. And on Friday, there were further signs of U.S. economic resilience, when personal spending data for March unexpectedly blew past economists' projections.
The dollar has also been supported by a jump in bond yields that's pushed them closer toward the rate of expected inflation. This month, the 10-year Treasury's real yield -- or what it is relative to expected inflation -- moved closer to breaking from below zero for the first time since the pandemic.
“It's the best possible combination for the dollar -- a rise in U.S. real yields at the same time growth vulnerability has increased outside the U.S.,” said Meera Chandan, a senior strategist at JPMorgan Chase & Co.
In the options market, sentiment on the dollar is the most positive in a month -- with room to get even more bullish toward a two-year peak seen in early March.
“If we were playing poker and we could take anyone's cards – Japanese cards, European cards, British cards – people want U.S. cards,” said Marc Chandler, chief market strategist at Bannockburn Global Forex.
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