Safe haven currencies

What the term claims, and what it does not 

A safe haven currency is one that has tended to strengthen during periods when financial markets are under stress. The whole of that definition is historical. It records where capital has moved in past episodes, and it is arrived at by looking backwards at a set of events and noticing that the same few currencies appear on the same side of them.

The word safe is the problem with the term, and it is worth disposing of at the outset. A haven currency is not safe in the sense of preserving value: these currencies move, sometimes violently, and the moves that earned them the label were themselves large. It is not safe in the sense of being reliable either, because the pattern has failed in identifiable episodes. What the label describes is a direction of flow observed under a particular kind of pressure, and nothing else.

The market's shorthand for the axis is risk-on and risk-off. In a risk-off period, assets perceived as carrying more risk are sold and a small set of assets is bought, and currencies sort themselves onto the two sides of that trade in a way that is largely independent of their own economies. The sorting is why a currency can strengthen on a day when nothing about its own economy has changed.

The three currencies, and why each is on the list 

The Japanese yen is on the list for a mechanical reason rather than a reputational one. Japanese interest rates were at or near the bottom of the developed world for decades, which made the yen the conventional currency to borrow in for positions funded elsewhere. Unwinding those positions requires buying the yen back, and a period of stress is precisely when they are unwound in quantity. The yen has therefore strengthened during stress because of an accumulated obligation to buy it, not because anyone judged Japan to be safer.

The Swiss franc is on the list for institutional reasons. Switzerland runs a persistent current account surplus, carries low public debt, has a long record of political and legal stability and a banking system built around the custody of foreign wealth. Those features have made the franc the conventional destination for European capital seeking to leave a currency, and they are structural features of the country rather than positions that can unwind.

The US dollar sits on the list for reasons that partly contradict the others. It is the currency of the world's largest borrower and its largest government debt market, which is the deepest pool of assets that can absorb capital at short notice, and it is the currency most international obligations are denominated in. A period of stress creates demand for dollars specifically, because obligations denominated in them still have to be met. This has produced dollar strength in episodes originating inside the United States, which is a result no reading based on economic strength would produce.

Gold is discussed alongside these currencies and is not one. It is quoted in dollars, it pays nothing, it is nobody's obligation, and its behaviour in stress episodes has been considerably less consistent than the summary suggests. It belongs to the same conversation and follows different rules.

Where the pattern shows up in prices 

The effect is largest where the two sides of the axis meet in one instrument. A cross that pairs a haven currency with a currency on the opposite side of the risk axis contains both legs of the trade, so both contribute in the same direction at once. AUD/JPY is the conventional example, which is why it is quoted so often as a sentiment measure rather than as a view on either economy.

The same reasoning explains why haven currencies are watched alongside equity volatility measures rather than alongside their own economic calendars during stress. Practitioners read them as expressions of the same underlying variable, and the correlation between them tightens sharply in exactly the periods when it is being relied on, which is a description of a regime and not of a rule.

The episodes in which it failed 

The failures are as instructive as the pattern, and they are not obscure. Four kinds recur.

1. The haven is the source of the stress. A crisis originating in the haven economy itself removes the reason capital was moving there. Nothing in the label anticipates this case, and it is the one in which the label is relied on most.
2. The authority intervenes against it. A central bank whose currency is strengthening in a way it judges damaging can intervene to stop it, and the Swiss National Bank's removal of its floor against the euro in the middle of the last decade produced one of the largest single-day currency moves on record, in the opposite direction to the one the floor had been holding.
3. The rate differential overwhelms the flow. The yen's haven behaviour depends on it being the low-yielding currency. In periods when other central banks raised rates rapidly while Japan did not, the yen weakened persistently through episodes of market stress in which the pattern would have called for the opposite.
4. Liquidity fails before the flow arrives. Haven flows arrive fast, and the thinnest hours of the trading day have produced disorderly moves in these exact pairs, including documented flash events in the yen crosses during the Asian early session.

What can honestly be taken from the label 

Two things survive scrutiny. The first is descriptive: knowing which side of the risk axis a currency has historically sat on explains a great deal of movement that would otherwise look inexplicable, particularly on days when a currency moves against its own data. The second is structural: the mechanisms behind each of the three, an accumulated funding position, a persistent surplus and a deep bond market, and the world's borrowing currency, are real features that can be checked rather than sentiment that cannot.

What does not survive is the extension from those observations to an expectation. The label is assembled from a set of past episodes, and each of them was described as unprecedented while it was happening. A currency's behaviour in the last crisis is evidence about its plumbing, not a commitment about the next one.