Why Do Investors Choose Safe-Haven Currencies?

Why Do Investors Choose Safe-Haven Currencies?

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The US dollar (USD), the Japanese yen (JPY), and the Swiss franc (CHF) – often referred to as the ‘Big Three’ – are the most widely traded safe-haven currencies globally. According to the Bank for International Settlements (BIS) latest Triennial Central Bank Survey, the USD is involved in approximately 90% of all trades, with the JPY and CHF on one side of nearly 20% and 5%, respectively. 

Safe-Haven Currencies Defined

When uncertainty hits, investors tend to gravitate towards currencies of economies with financial and economic stability: the USD, the JPY, and the CHF are, as noted above, commonly cited as the go-to safe-haven currencies.

Economic uncertainty, which often leads to elevated market volatility, can trigger risk-off conditions and prompt demand for the said currencies as investors look to preserve capital and mitigate risk exposure. Investors expect safe-haven currencies to appreciate during uncertain times or at least retain their value. 

What makes currencies a safe haven are countries with strong, reliable and large economies, often with stable/low inflation rates and robust governance. The political stability of a country may also result in the national currency being considered a safe haven. Additionally, a safe-haven currency must have the available volume for investors to transact quickly in large amounts without the risk of big price movements (also known as liquidity). Each of the Big Three currencies possesses the aforementioned characteristics, making them appealing during times of economic unrest.

The Big Three: USD, JPY, and CHF

Serving as the world’s primary reserve currency since World War II, the USD is held by central banks globally and forms part of their foreign exchange reserves to conduct things like international trade and financial transactions. This often makes the USD a natural choice for investors seeking a safe-haven investment. The USD is backed by the largest economy in the world based on nominal Gross Domestic Product (GDP) – the United States (US) – and is influenced by several factors, including central bank policy (the US Federal Reserve), the economy, and geopolitics. 

The JPY represents Japan's currency, which is the 3rd largest economy according to nominal GDP. Given Japan’s sizeable economy and liquid financial markets, the JPY is considered a strong safe-haven currency despite elevated sovereign debt levels. Japan’s debt-to-GDP ratio – a measure of a country's ability to repay its debt by comparing its government debt to its GDP – is currently the highest in the world at more than 250% (see the chart below for a comparison of gross government debt as a share of GDP in advanced economies). While Japan has increased debt levels, the country continues to benefit from a current account surplus; from April to September this year, the country’s current account surplus rose to a record high of ¥18.8 trillion (more than US$100 billion) as businesses generated higher returns from their overseas investments. The JPY, however, is influenced by various aspects, including the Bank of Japan's (BoJ) monetary policy, the Japanese economy, and geopolitical events.

Switzerland ranks as the 20th largest economy in the world by nominal GDP and uses the CHF as its primary currency. The country's long-standing political neutrality in international affairs, strong political stability and fiscal prudence, as well as robust banking system contribute to its reputation as a safe haven for investors. The Swiss National Bank's (SNB) commitment to maintaining currency stability also enhances the Swiss franc’s appeal as a safe-haven investment.

Trading Safe-Haven Currencies

It is important to understand that while the USD, JPY and CHF are recognised safe-haven currencies, investors may opt for alternative investment options during economic uncertainty. This can include investing in Commodities, Bonds, as well as defensive sector Stocks, like Utilities, Consumer Staples, and Healthcare. Investments in Digital Currencies, which could eventually challenge the traditional role of safe-havens, are also rising. However, the volatility and uncertainty in the Digital Currency market may limit their appeal in the short term. 

For portfolio investors, safe-haven currencies are frequently used as a risk management ‘tool’. Investors may allocate a portion of their portfolio to safe-haven currencies to help shield their portfolio during market downturns. This strategy is also particularly relevant for cross-border businesses and organisations exposed to currency risk.

When economic or geopolitical uncertainty hits or is expected to, and given sentiment will likely favour buying safe-haven investments, traders may seek technical buying opportunities; this could be as simple as a resistance breach to more complicated approaches involving technical indicators and more advanced patterns. 

In conclusion, safe-haven currencies are vital to the global financial system. As investors seek to protect their wealth and mitigate risk, these currencies will continue to be a popular choice, especially during times of economic and geopolitical turmoil. It is important to note that while the ‘Big Three’ are generally considered safe-haven currencies, they are not immune to market fluctuations. Factors such as interest rate changes, economic indicators, and geopolitical events can all impact their value.

FAQs:

1. What are safe-haven currencies? 

Safe-haven currencies are those currencies which often appreciate or retain value during economic uncertainty or geopolitical issues. Investors tend to seek safe-haven investments to attempt to shield their wealth and mitigate risk exposure. 

2. What are the ‘Big Three’ currencies?

The Big Three currencies include the most common safe-haven options within the Forex market: the USD, JPY, and CHF. They are popular safe-haven options due to their liquidity, stable national economies and political stability.

3. How do market participants use safe-haven currencies?

Safe-haven currencies are used in different ways. Portfolio investors tend to allocate a portion of their portfolio to safe-haven investments, while traders may seek short-term opportunities based on uncertainty.