Investors Rethink Options in Safe Haven Currencies as the World Slumps Toward Recession

As traders, we are entering a new era in the Forex markets. Over the past 3 years, we have managed find some form of order among the economic uncertainty and disorder. This order may not have been rational, right or even made any sense, but at least we had an expectation of direction depending on the overriding market sentiment.

What I am talking about is the ‘Risk on, Risk off’ trade that saw the traditional safe havens of the U.S. dollar, Swiss franc, Japanese yen and gold enjoy investor flows when risk aversion was rife. Conversely, in those small time periods where we dared to allow ourselves that little shred of optimism, we could jump into the higher yielding markets such as the Australian dollar, New Zealand dollar and even the euro to enjoy higher rates coupled with an appreciating currency. Due to the one sided nature of these moves and the real possibility of slipping back into recession (some might argue we never came out of recession), these safe havens have become increasingly overvalued leaving central banks and governments little choice but to implement measures to artificially depreciate their currencies in order to protect their own economies.

The sovereign debt concerns in the peripheral Eurozone nations have been a constant weight around the neck of the single European currency.  Now, it has reached a point where some experts have called into question the sustainability of the euro itself. Logically speaking, a single monetary policy being applied collectively to nations with differing economic capabilities is a very difficult task. However, add the fiscal irresponsibility and the mounting debt held by certain members of the EU and that task truly becomes ‘mission impossible.’  Investors have been brutal in punishing the likes of Greece, Portugal, Italy and Ireland by demanding higher yields on bonds issued. This has exacerbated the crisis by making it nearly impossible for these peripheral nations to fund their fiscal obligations.

This may seem like a self-contained crisis with the damage limited primarily to Europe. Unfortunately this is not the case. To make matters worse, the holders of these bonds have managed their risk using credit default swaps, a form of insurance that protects them in the case of default. According to the headlines, the insurers are U.S. institutions meaning that although the epicentre of this crisis lies in the heart of Europe, the aftershocks may well be felt across the Atlantic.

With the United States narrowly avoiding a default of its own, but still suffering a downgrade by one of the big credit rating agencies they have their own problems. The world’s largest economy has attempted to stimulate its economy with accommodative monetary policy with little success. Ben Bernanke used last month’s public appearance as an opportunity to remind the U.S. government that they have a responsibility to ensure that its fiscal house is in order if the U.S. economy is to find its way back to prosperity.

Right, I digress – back to the currencies! The sovereign debt concerns in the peripheral Eurozone has ensured European investors looking for a safe haven turn to the Swiss franc to park their capital. The Swiss National Bank embarked on numerous attempts at intervening in the market as safe haven flows appreciated the value of the Swiss franc to levels detrimental to the Swiss economy, but had previously failed.  Since 2009, investors have been relentless in their pursuit of the Swiss franc and in the process drove the currency to record highs against the euro and the U.S. dollar.

This trade rewarded Forex traders each time risk aversion drove sentiment. Each time rumours of a Greek default made headlines, the franc rallied. Each time President Obama revealed no progress had been made on the debt ceiling, the franc rallied. Essentially, any form of risk aversion was used as an excuse to jump into the franc.

However, this once simple trade that provided order in a disorderly market came to an abrupt end in September. The Swiss National Bank realising drastic action was required revealed the franc had become a problem for export competitiveness and deflation. After futile attempts to devalue the currency over the past 18 months, they implemented a strategy that has left long franc holders a real reason to reconsider their positioning.

The Swiss National Bank has placed a floor beneath the EUR/CHF and USD/CHF at 1.20 and 0.83 respectively. The act of devaluing their currency has been followed with rhetoric stating that they will protect these levels with real determination and that they are willing to buy foreign currencies in unlimited quantities.  These are real words of intent that have effectively ruled out the Swiss franc as a trade we can rely on in times of uncertainty.