Why the dollar will stay strong despite the US 'fiscal cliff'

New York: "What's going on with the US dollar? Why is it so strong?" asks a friend who has arrived from India. "Surely it should be much weaker than this?"

She has a point. Markets and investors are on edge due to uncertainty over the "fiscal cliff," a combination of spending programs and tax cuts that expires at year end. If an agreement isn't reached in the bickering US Congress among Democrats and Republicans to avoid it, growth prospects in America will be seriously dented. Economists have already warned that if left unaddressed by Congress, the fiscal cliff could throw the US economy into a recession next year.

In a twist, that could actually help the US dollar, given that the greenback is widely considered a safe haven currency purchased during times of market stress. In fact, the dollar has already got a boost from investors' obsession with the fiscal cliff. The negotiations on Capitol Hill have fuelled a renewed demand for the dollar.

The greenback shows resilience - in good times and bad. Reuters

"We still look for the USD to remain favoured as a safe-haven into year-end and for the relative US economic advantage to buffer any fiscal cliff-related drag and to act as a USD support in 2013," Brian Kim and Brian Daingerfield, currency strategists at the Royal Bank of Scotland, told CNBC.

A US recession alone will not stop capital from flowing into the US safe haven asset. On the contrary, the global impact that such a development would have would accelerate inflows into dollars and Treasuries.

"President Obama and Speaker of the House Boehner made it clear in their respective statements that the tension is still on. In the meantime, however, the stronger the risk aversion move, the more support the dollar will find," said Investopedia, the world's largest financial education resource.

Few analysts expect the rupee to fall back towards the record low of Rs 57.32 seen in late-June, but it fell to a fresh 11-week low of 55.87 rupees against the dollar on Monday as investors remained wary after the winter session of parliament was adjourned for the third consecutive day this week.

The rupee was also hurt by strong dollar demand from oil importers to meet their payment obligations in the last week of the month. Unfortunately, the stubborn strength of the dollar is bad news for Indian travellers and students looking to study in America. The dollar-rupee pair is likely to remain in a broad band of 54.80-56.20 rupees in the short term, according to currency traders.

The dollar was little changed on Monday against most other major currencies as eurozone finance ministers discussed the strings that would be attached to the next aid payment to Greece.

Updated Date: Dec 20, 2014 14:20 PM

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