fx safe havens

Global currency markets have become increasingly volatile as European policy-makers struggle to resolve the sovereign debt crisis and emerging economies try to limit currency rises at the same time as taming inflation. Traditional safe haven countries have been prompted to take historic action in a bid to stem currency appreciation and support exports. But are there any safe havens any more?

For most of 2011, Asian and other emerging market currencies moved consistently higher against the dollar, but their seemingly unstoppable appreciation came to an abrupt end in September. The falls began in Asia, where the South Korean won dropped by 2.2% against the dollar on September 19, 2011, followed by the Indonesian rupiah, which fell by 1.5%.

By the same date, the Asia Dollar index, compiled by JPMorgan and Bloomberg, which tracks the region’s 10 most traded currencies (excluding the yen), had fallen 2.5% against the dollar, wiping out almost all of the gains made since the start of the year.

Domino effect 

The negative sentiment quickly spread to currencies in emerging Europe and Africa. The South African rand fell by more than 3% against the dollar – reaching its weakest level since July 2010 – while the Hungarian forint fell to its lowest level in more than a year against the euro. The Polish zloty also lost just shy of 2% against the single currency, as the sell-off spread to the European timezone.

The falls are due to a toxic combination of factors. At the forefront is the fear that the eurozone debt crisis will ripple out to damage even the fastest-growing economies, as demand for their exports falls and capital flows become more volatile.

Worries about the eurozone increased when European finance ministers met in Poland in mid-September but failed to announce any sort of resolution for Greece’s debt crisis. Many market participants talk of when, not if, Greece defaults.

Even as investors turn back to the safe haven of the dollar, concern that the outlook for the US remains tepid at best is also punishing emerging market currencies, particularly those most vulnerable to a slowdown in the US. At one point in mid-September, for example, the Mexican peso was pushed down to 12.6910 pesos against the dollar, not far from its 52-week low of 13 pesos, because of the countries' proximity and close business ties.

Inflation fears

Emerging markets’ homegrown policy responses to the global slowdown are also having an impact on currency valuations. Brazil's central bank cut interest rates by 0.5 percentage points to 12% at the end of August, citing the gloomy outlook. The rate cuts have weakened the real sharply; it traded at 1.6557 against the dollar in mid-September, not far from its 52-week low of 1.7396.

In Asia, the need to support flagging growth has to be balanced with the continued presence of inflation. In some cases, policy-makers and central bankers are allowing their currencies to depreciate in the hope that it will give exporters a boost in the process. “The risks of a slowdown are becoming more evident but the persistence of core inflation means that they are not ready to cut interest rates yet,” says one banker.

[For FX investors], there is nowhere left to hide

HSBC research

Historic intervention 

In Europe, Swiss policy-makers were prompted into an historic intervention because of fear about the economic costs of the high valuation of the Swiss franc. In September, the Swiss National Bank imposed a ceiling on the franc for the first time in more than three decades.

Saying that it was “aiming for a substantial and sustained weakening of the franc”, the Zurich-based bank said “it will no longer tolerate a euro-franc exchange rate below the minimum rate of 1.20 francs” and “is prepared to buy foreign currency in unlimited quantities”.

The Swiss action followed a series of moves by the Japanese central bank as Tokyo intervened in the exchange-rate market and eased monetary policy in August in a bid to stem the rise of the yen, another safe haven currency, against the dollar. The Bank of Japan has signalled its readiness to ease further if sharp yen rises hurt business sentiment and threaten prospects of economic recovery.

No safe ground

Research from HSBC says that such actions mean that the notion of a safe haven is retreating, if only temporarily. For FX investors, it says “there is nowhere left to hide”.

To earn safe haven status, countries must have a long-term track record of inflation control, a long-term record of control over public finances, and a strong external position. In addition, the country should display political and policy stability and its FX market needs to be open and have sufficient liquidity. 

In September, HSBC’s FX strategy team analysed the structural characteristics of 25 countries; its conclusions are stark. “The actions by the Japanese and Swiss authorities have effectively removed, at least for now, the two traditional safe haven currencies from the market.

"Of all the alternatives, the Canadian dollar is probably the next best option, but the case for it is far from overwhelming. The conclusion has to be that, in the FX market, there is no place to hide, and there will probably be further upward pressure on the price of gold.”

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