Sunday, July 3, 2011

Improve your understanding of safe havens in the fx market

Explaining


a safe haven currency


A safe haven currency


is a currency that is considered to be safe during


geo-political and economic turmoil.


Consequently, when events like natural disasters,


war and stock exchange crashes occur, forex


traders invest in safe havens, causing the value of the safe haven currency to


rise and the value of currencies paired with it to fall, even though


the events may not have had an obvious impact


on the aforementioned currency.







What are the features of a safe haven currency?

Due


to the popularity of the carry trade, interest rate differentials


have often been connected with


safe-haven status. Nonetheless this trend isn't consistent across


the market, as it only looks to be an element when


trading the currencies of advanced states in opposition to emerging states.


This suggests that the liquidity of the currency being


traded is a driver of safe-haven status, as major currency pairs


have larger liquidity than exotic currency pairs.

Also, when


worldwide risk aversion is high, liquidity in some markets may


dry up, causing traders to take a position in very


liquid currencies. In turn, this gives the most liquid currencies an extra boost.

For a country to be


thought to be safe and low risk, it should be


isolated from worldwide events in case there's a crisis, and it should have good


fundamentals, like industrial management and


strong industry. In theory, the currencies of


such states might be seen as safe


haven currencies.

In practice, it is


more difficult to gain isolation in


an increasingly globalised world. So factors like the size of a


country's stock market, which indicates its


finance development and market size, now appear to outweigh the external


vulnerability associated with its net foreign


asset position.








What are the main


safe haven currencies?


The USD,


CHF and JPY are all called safe haven currencies. However, because


of the carry trade the fact that the Japanese Yen rises


during periods of global


chaos is likelier to be a reversal of


investors' carry trades ( which generally go long on a


currency with a high interest rate against currencies with low interest rates,


like the yen ) instead of a conscious


investment in the currency.

The CHF


is believed to be a safe-haven currency for a number


of reasons: first, the CHF is a particularly liquid currency and is paired with the USD.


Next, Switzerland has a highly competitive business


environment, along with low company tax, a


clear economy and a history of good


business management. Following,


Switzerland is historically neutral, so it is viewed as less


likely to be affected by political turmoil in


Europe than the euro. Fourth, the Swiss National Bank keeps a large


part of its reserves in gold, causing the


CHF to appreciate with the cost of gold.

Although the


CHF briefly dropped in value in the


global finance crisis due to its exposure


to the banking sector, it has since


regained its footing as a safe haven currency, and has


attracted investors as {several members of the eurozone|Greece,


Portugal, Italy and Ireland|several eurozone members|several


eurozone members (such as Greece, Italy, Ireland and Portugal |several members of the eurozone (such as


Greece, Italy, Ireland and Portugal struggle.




Why is the USD a safe haven


currency?


If we have a


look at the factors that contribute to a currency being a


safe haven, the US and the dollar don't measure up. The US is


not insulated from world events,


having major trading partners across North and Central America, Asia and


Europe. The US has not entirely recovered from the


finance crisis, with unemployment still around 10% and expansion having slowed again for the 3 quarters


to June 2011.

So why are


not currencies like the CAD and AUD (both of which are from nations that


didn't suffer from a banking crisis or a recession, and both of


which have robust economies and lower unemployment rates than the US)


thought to be safe haven currencies?

The Aussie


dollar, Canadian dollar and New Zealand dollar are all commodity


currencies, meaning that, as commodity exports contribute significantly to their GDP, they usually benefit


from strong commodity prices. Strong commodity prices are


inspired by a strong international economy,


meaning that when the world economy might be in peril, these currencies fall in value as investors turn to


safe havens.







So why is the US dollar considered to be a safe haven?

The most significant reasons for this are the size of the


US economy, including the


widespread utilisation of the US


dollar worldwide, the belief in the US dollar


as a safe-haven currency, and the liquidity of the US dollar.

The majority of fx trades involve the US dollar: the major currency pairs are all


paired with the US dollar, and formulas to work out


exchange rates between crosses ( currency pairs that don't contain the US


dollar ) use the US dollar exchange rate. As liquidity is how short-term currency traders make their profits, there are


continually numerous trades being made on the US dollar. In a risk


averse environment, we have already acknowledged that liquidity in some


markets dries up. This leads to more traders to invest in the most


liquid currencies, of which the USD is at the top


of the heap.

 As the USD has been said to be the world's top safe-haven


currency for years, there is a prevailing sentiment in the market


that the USD is safe, no matter what the present commercial


data might show. This is among the reasons


explaining why the USD strengthened in 2008


in spite of the financial


emergency: it was still seen to be more safe than


other markets.

The main


reason that the USD is considered to be a


safe haven currency is that the USD is "too big to fail".


Currently there are far more US dollars in circulation internationally than any other currency, with two thirds of


the remainder of the world's foreign reserves denominated in US


dollars. If the USD falls by too much, it will have


implications across world markets.


The dominance of the USD, and the dominance of the US in world


trade, means that other central banks won't permit the dollar to fail.     









Improve your knowledge of the currency markets and how to place a fx trade with education tools and free webinars.Remember: CFDs and forex are geared products and may result in losses that surpass your initial deposit. CFD trading might not be suitable for everyone, so please make sure that you understand completely the risks.

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