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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