🔔 FX: Know Your Safe Havens

Following on from yesterday, we'll take a look at the differences within the currency groups we used:

We'll start with the dollar: The dominant global currency, and in a group/league of its own.

It's the dominant currency in global trade, FX reserves & transactions, international debt.

A 2019 central bank survey by the Bank for International Settlements found that the USD was bought or sold in 88% of Global FX transactions...

Everyone always needs dollars.

Take a look at these charts. Everything blue is USD... 👇

KEY POINTS:

• For most of the last century, the pre-eminent role of the U.S. dollar in the global economy has been supported by the size and strength of the U.S. economy, its stability and openness to trade and capital flows, and strong property rights and the rule of law.

• As a result, the depth and liquidity of U.S. financial markets is unmatched, and there is a large supply of extremely safe dollar-denominated assets.

• A key function of a currency is as a store of value which can be saved and retrieved in the future without a significant loss of purchasing power

• Over the period 1999-2019, the dollar accounted for 96% of trade invoicing in the Americas, 74% in the Asia-Pacific region, and 79% in the rest of the world. The only exception is Europe, where the euro is dominant

The above is taken from this excellent paper: The International Role of the US Dollar (worth a read as it's not too long, technical or academicky) 👇

The Dollar Smile:

So, that's the dollar covered.

Now we'll look at the other Safe Havens and Funding Currencies

Starting with...

The Japanese Yen

Japan's economy is well-developed, yet economic growth remains stubbornly low.

With an ageing population and high debt levels, the central bank has committed to keeping rates at or near zero, including yield curve control to anchor the ten-year yield at or near 0%.

Bottom line: you don't get rewarded for 'savings' in Japan.

So, Japan takes its yen and heads out into the world to invest it.

Their status as the world's biggest creditor nation has been maintained for the past 30 years (creditor nation = those that lend more money to the world than they borrow from the world).

And there's a strong correlation between USDJPY and the US 10 year bond yield.

The correlation makes sense. The Yen is sensitive to international economic conditions.

If the economic outlook is positive, US bond yields will tend to rise as investors ditch the safety of bonds and hunt higher yields elsewhere.

US bonds and yen are both sold when investors are seeking risk and hunting for higher yields/returns.

Which is why investors tend to use JPY for carry trades.

Essentially, they borrow Yen (funding currency) to fund the purchase of higher yielding foreign assets.

In times of economic stress, those trades are reversed (carry trade unwind) so Yen demand increases & the Yen strengthens.

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The Swiss Franc

The Swiss Franc also benefits from safe-haven status, due to its exceptionally stable government and financial systems, tax-haven status and geopolitical neutrality.

It's so safe that even with deeply negative interest rates (deposit rate is currently -0.75%), the currency still appreciates in times of stress.

The Swiss National Bank (Central bank of Switzerland) actively intervenes in the currency markets to try and weaken the Franc (or at least push back against excessive CHF strength).

The SNB are also an investment fund with approximately $157 billion AUM (1st November 2021) and hold stakes in some of the world's largest companies including Apple & Microsoft.

Similar to the yen, the CHF is used to fund overseas investments, and the bank deposit rate is set at a level that discourages savings.

In 2011, the CHF was pegged to the Euro at 1.20.

In 2015, the peg was famously abandoned and the rate plummeted below parity...

Ever since, the SNB has a policy better described as exchange rate management.

Simply, whenever the Franc gets too strong, they 'print' more Francs to buy Euros and dollars and weaken the Swiss currency.  

That covers the true safe havens and funding currencies.

Next up in the series, we'll take a proper look at the Euro & why it's used as a funding currency but doesn't really deserve safe haven status...

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