Safe Haven Currency Overview - State Street Global Advisors

SSgA CAPITAL INSIGHTS VIEWPOINT
Part of State Street’s Vision thought leadership series
Currency Insight:
Safe Haven Expansion?
PHOTO
by
Thomas F. Bailey,
Vice President, FX Trading,
Boston Trading Desk
The Foreign Exchange (FX) market is a 24hr-a-day market,
trading continuously from the open in New Zealand on Sunday
night through Friday afternoon in North America. It is the largest
market in the world and averages a turnover of approximately
$4.0 trillion USD a day. According to the Bank for International
Settlements (BIS) Triennial Survey of 2010, global FX turnover is
up approximately 20% since April 2007. The survey suggests that
trading activity amongst the “other financial institutions” subset
that includes hedge funds, insurance companies, and central
banks among others has contributed $1.9 trillion to the global
FX turnover between 2007 and 2010. The report also suggests
that the bulk of the daily FX trading activity occurs in the UK
where over 1/3rd of the daily volume is traded, followed by the
US and then Asia. Over the 2007–2010 time period, the BIS
Survey indicates that EUR/USD is the most traded currency pair,
followed by USD/JPY, GBP/USD, USD/CHF, and AUD/USD. The
USD remains the most commonly traded currency, involved in
85% of all FX transactions. Cross currency pair volume continues
to increase as Euro crosses like EUR/GBP, EUR/CHF, and EUR/
SKANDI (NOK, SEK, DKK) become more popular. 1 But as with
markets, safe havens and what are considered to be safe havens
can change from one market to the next. This paper looks at safe
havens; what they usually consists of and some new safe havens
that are gathering attention and about which investors should be
aware.
Given the fragile state of the global economy, safe haven
currencies have seen good demand of late. Sovereign debt
issues in the Eurozone, the accompanying inability of politicians
to agree on a viable solution in the region, and the general
slowdown in global growth have put the global economy in a
tenuous position. As such, investors in large part have remained
on the sidelines, creating a thinner currency market with higher
volatility. Going into the Global Financial Crisis in late 2007, FX
Volatility as measured by the Deutsche Bank FX volatility index
(CVIX) climbed +300% from June 2007 to June 2008. Though
that level of volatility has subsided, it has not disappeared. As
such, investors continue to look for portfolio protection found in
safe haven currencies.
Safe haven currencies are generally defined as an asset that is
safe and secure from increased volatility and have the potential
to appreciate when risk sentiment is under pressure. According
to Goldman Sachs, safe haven currencies have historically been
those that are associated with countries that have account
surpluses, are a global net creditor, have low inflation, and are a
commodity exporter. 2 While the latter definition is a good place
to start, it is interesting to note that the most popular safe haven
currency, the USD, has none of these attributes. 3 Despite being
an outlier versus the parameters outlined by Goldman, the USD
continues to find good demand on the back of the market risk
events of the past 3 years. 4 Despite having credit issues of its
own (S&P ® downgrade being the most prominent), the USD
has remained in consistent demand as a safe haven, as can be
seen in Chart 1.
Demand for US assets comes largely on the back of the safety
and stability that the US provides in times of crisis. Also helping

SSgA CAPITAL INSIGHTS | SAFE HAVEN CURRENCY OVERVIEW
Chart 1: The DXY
1.6
1.4
1.2
1
0.8
0.6
2007 2008 2009 2010 2011 2012
— AUD Curncy - Last Price (L1) — DXY Curncy - Last Price (R2)
— EUR Curncy - Last Price (L1) — FXJPEMCI Index - Last Price (R2)
Source: Bloomberg.
Past performance is not a guarantee of future results.
drive demand is the understanding that when investor risk
appetite declines, USD-denominated assets remain liquid and
present less of an issue within their respective portfolios. In
these scenarios, the US dollar continues to to be seen a store
of value at a time of great uncertainty in the market; credit
issues and weak fundamentals have not driven investors away.
The liquidity of the US bond markets as well as the US dollar’s
status as the world’s reserve currency will help to keep the US
atop the safe haven list for the foreseeable future.
The CHF and JPY have historically run alongside the USD in
the safe haven equation. The CHF is viewed as a safe haven
due to the stable economic position and good fundamentals
of Switzerland. The CHF as a currency benefits from low
unemployment, low inflation and a strong economy. The
currency is also in demand in times of crisis due to the stability
provided by the Swiss National Bank. The SNB remains
staunchly conservative with not much appetite for quantitative
easing and the recent central bank intervention on the back of
the rapid ascent of the currency takes some of the shine off of
the CHF over the medium term. Nevertheless, in times of crisis,
CHF will remain a benefactor of the flight to safety.
The JPY is considered a safe haven currency largely because
the nation is a global net creditor. By definition, a net creditor
like Japan owns more foreign reserve assets than other nations
own of Japanese assets. Japan is currently the world’s largest
creditor, and is followed by China. 5 This status is certainly
attractive to investors in a time of crisis as it can provide a
feeling of stability in an otherwise uncertain market, given
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Japan’s sound economic standing. The fact that the BOJ
followed the SNB on the intervention trail also helped the
Yen’s safe haven status. Near term sentiment is that the JPY
will continue to be supported as a safe haven play. Continuing
sovereign debt issues in the Eurozone during a time of slowing
global growth will lead investors to the JPY as the currency
offers political stability, liquid local markets and offers
favorable fundamentals.
Like the USD, CHF and JPY, the CAD appears to offer a
“safe” investment to investors as well. With the Eurozone
sovereign debt crisis seemingly expanding by the day and the
US downgrade in 2011, CAD bonds may present themselves
as a viable option for investors seeking to add some safety to
their portfolio. In addition, the Loonie attracts interest as a safe
haven based on the security of the Canadian banking sector
(financial regulations) and the strength of the nation’s fiscal
position(budget management, credit rating). However, the fact
that Canadian capital markets remain a fraction of the size of
their peers in the US and Japan 6 may give caution to investors
who are wary of sharp moves in shallow markets. As a result,
the CAD will likely remain a second tier safe haven currency
over the longer term.
GBP and the Scandinavian currencies have also attracted some
attention as possible safe havens for investors. With regard
to Great Britain, declining fundamentals and the prospect of
an increase in quantitative easing will continue to weigh on
the currency and make it less attractive to investors who are
looking for a conservative investment. Of late, the GBP has
remained well-supported as a safe haven currency on the back
of the continuing credit crisis in the Eurozone, declining growth
prospects in the region, and improving data prints.
While Scandinavia certainly provides a place to park an
investment, the market remains a bit skittish and is a bit
reluctant to fully embrace these currencies as true safe haven
alternatives. Concerns seem to center on whether the market
offers sufficient depth during times of volatility. After all, the BIS
estimates that the daily traded volume of the Norwegian Krona
is only 1.3% of the $4 trillion traded daily. To be effective, safe
havens need to provide a reduction in volatility but also deep
markets; in other words, market depth matters.
Safe haven currencies are not the only option in this market,
however. Investors may also consider highly rated sovereign
debt as a safe haven as well. If we consider highly rated
2

SSgA CAPITAL INSIGHTS | SAFE HAVEN CURRENCY OVERVIEW
sovereign debt first, it’s clear that German Bunds and US
Treasuries are generally the most attractive safe havens in this
sector. In the current environment where investors are spooked
on the back of the Eurozone crisis (defined by increasing debt,
declining growth and default concerns), being long German
Bunds with CDS protection may present itself as an attractive
investment. In this case, investors know what they are getting
and have some peace of mind of protection. 7 Historically,
the price of US equities and the price of US Treasuries have
had a negative correlation. But for investment managers, US
Treasuries have been, and can be, used to help soften the blow
of declining securities within a given portfolio. In general terms,
when equities declined over the past decade, US Treasuries
rose. Specifically, when the S&P declined by 14% in Q3 2011,
and as a result, realized their biggest loss in two decades, US
treasuries realized their second biggest rally during the same
time span. 8
But what about commodities as a safe haven? Gold has also
attracted some interest of late. After all, declining global markets
and lingering uncertainty mainly due to inflationary concerns
on back of global QE initiatives has spurned demand for the
precious metal. However, the precious metal is likely too volatile
of an asset for investors to truly consider it a safe haven option.
When global assets are in decline, investors seem to flock to the
safest of the safe with US Treasuries and German Bunds—gold
falls into the second tier category when it comes to safe haven
demand.
The SSgA Global FX trading desks execute FX wherever there
is an available 3rd party FX market. These include the G20
currencies and all emerging markets (EEMA, ASIA EM, LATAM
EM) currencies where available. Based on figures over the last
3 years, the SSgA Global FX desk concluded that they execute
approximately $760 billion annually across the desks in London,
Hong Kong, and Boston. This type of operation helps give us
the ability to see these ebbs and flows into both traditional and
emerging safe haven options.
In the end, safe havens have risen in popularity on the back of
the rising correlations within the recent crises’ global markets
have endured over the past 3 years. While it is likely that we
may see some atypical safe haven currencies sought after in
future times of crisis, we believe the feeling in the market is that
the major safe haven currencies will remain the USD, CHF and
JPY. We believe highly rated sovereign debt like German Bunds
and US Treasuries will also continue to remain in demand in
time of increased market stress.
1 Triennial Central Bank Survey, Detailed Final Report on FX Activity, December 2010
2 Goldman Sachs, Global Markets Daily, September 28, 2011
3 Ibid
4 These include the Lehman collapse, the first signs of the need for a Greek bailout,
and more recently, the Eurozone contagion fears associated with Greece bailout
5 Reuters.com, 5/21/12
6 BMO FX Commentary, 5/31/12
7 Bank of America/Merrill Lynch “Curse of the Vanishing Safe Havens”, October 19, 2011
8 Goldman Sachs, Global Markets Daily, September 28, 2011
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SSgA CAPITAL INSIGHTS | SAFE HAVEN CURRENCY OVERVIEW
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The views expressed in this material are the views of Thomas Bailey through the period ended September 30, 2012 and are subject to change based on market and other conditions. The information
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