Market turmoil unavoidable? Under the impact of energy, the safe haven status of the US dollar fades, and cash may become the "least bad" choice.

Where should investors go to hide from the market turmoil caused by the Iran war? At present, there is no reliable safe haven; even the traditionally largest beneficiary of risk aversion, the US dollar, has only recorded moderate gains compared to major global currencies. Funds flowing into the US dollar have clearly not been heavily invested in the struggling US stock or bond markets, but rather held as cash. The price of gold has fallen by a quarter from its peak at the end of January; bitcoin has plummeted by over 40% from its record high in October last year, shattering hopes that cryptocurrencies can provide shelter in times of crisis. Volatility in almost all asset classes has soared. Although European and American stock markets have so far seen relatively modest declines, if fixed income markets continue to signal a sharp rise in inflation, the resilience of the stock markets may not last. Fairly speaking, asset classes that have recently shown strong gains are easily becoming a source of liquidity. For example, gold has still risen by 35% in the past year and 130% over the past five years; if the conflict continues, central banks that have accumulated large amounts of gold in recent years may use these reserves to meet energy and defense needs. One explanation for the relatively flat performance of the US dollar is the sharp rise in interest rate expectations in energy-short regions (especially the eurozone and the UK). Given the prospect of high energy prices, the euro and pound usually come under pressure as investors withdraw; but futures markets quickly repriced the policy outlook for the European Central Bank and the Bank of England, anticipating that both would adopt hawkish interest rate hikes. The situation in the US is different, with a relatively mild change in interest rate expectations. Futures markets currently believe that the Federal Reserve will remain on hold for the rest of the year, compared to previous expectations of a more dovish policy. The difference in official interest rate prospects has restrained the rise of the US dollar - but the currency market may quickly shift focus from relative interest differentials to deteriorating growth prospects, which will put pressure on the euro and pound. In the eurozone economy, which is suffering external supply shocks and near-stagnant economic growth, it is difficult to predict whether multiple interest rate hikes will really be implemented. If policymakers repeat the mistakes made after the Russian-Ukrainian war in 2022, triggering an economic recession or at least severe economic downturn, it could be a huge mistake. Four years ago, Western economic demand was still supported by monetary and fiscal stimulus measures after the pandemic, with inflation quickly rising above targets and widespread declines in unemployment. Today, the situation is exactly the opposite. Moreover, if energy prices remain high, demand may be depressed, leading to deflation: analysts at UBS Group point out that "the likelihood of rate hikes may be increasing, but the likelihood of significant rate cuts is also significantly increasing." Fairly speaking, Bank of England Governor Bailey has strenuously emphasized that the decision to keep interest rates unchanged last week did not signal a path to interest rate hikes for policymakers. However, if rate cuts are no longer seen as a certainty by the market, a rapid repricing in the opposite direction is likely. The problem is, when everyone takes the same action at the same time, adding margin requirements will exacerbate market volatility and may trigger an overreaction. Policymakers are highly sensitive to accusations of acting slowly in responding to inflation in the post-pandemic era and are vigilant about any remaining impacts that may still exist. Once signs of pent-up consumer price pressures emerge, they will hope to act more quickly this time. But the extreme volatility in the government bond market in recent times has played a role in raising borrowing costs that far exceeds the power of central banks alone. Recently, the yield on 10-year German government bonds briefly rose above 3%, Italian government bond yields broke above 4%, and UK government bond yields rose to over 5%. The result is rapid increases in mortgage and loan rates, sending out a widespread contraction signal that any central bank aiming to contain inflation would welcome. If soaring energy prices trigger a recession, in this potential roller-coaster market situation, there is no obvious safe haven for investors to safely endure, let alone accurately grasp market rhythms. For investors, holding cash (holding US dollar cash) may be the least bad option; but even for the US dollar as a safe haven, market confidence is not high.