Demand for currency safe havens still strong notes Neuberger Berman’s Ugo Lancioni
Ugo Lancioni, manager of the Neuberger Berman Diversified Currency Fund, writes in his latest quarterly note that the market is still focused on safe havens.
The third quarter of 2011 was characterised by sharp deterioration in risk appetite as the uncertainty surrounding the sovereign debt issues in Europe started feeding into the global real economy. The Japanese yen, US dollar and British pound outperformed the other major currencies over the quarter, while the Australian dollar, Canadian dollar and New Zealand dollar were the worst-performing currencies.
Despite the attempts of policymakers to restore investors’ confidence, the market uncertainty increased during July, causing a sharp drop in risk appetite and triggering large flight to quality currency flows. In fact, the intensification of the Euro-zone sovereign debt crisis combined with the endless debate on the US debt ceiling caused further demand for “low debt currencies”. Investors also aggressively bought so called “safe haven” currencies (with the exception of the USD), regardless of stretched long term valuations and other, normally important dynamics.
The Swiss franc and the Japanese yen appreciated sharply, ending the month up against the USD by about 7% and 5% respectively. The sharp widening of the spread between Italian and German yields was the key game-changer in July and caused an acceleration of the price action in many crosses. The disappointing price developments in the Italian and Spanish bond market occurred in spite of the strong commitment towards the single currency shown by the Euro-zone leaders.
August was another month of extraordinary events. The S&P downgrade of the US’s long-term credit rating to AA+ from AAA contributed to further deterioration in sentiment and triggered a sharp pick up in FX volatility. The currency price action was magnified by trading volumes well below average, as investors are traditionally less active in August due to summer holidays. During the first couple of weeks of the month, flight to quality and safe haven flows continued to dominate the price action.
In fact, a number of developments combined turned into a deadly mix for risky assets; a) the US downgrade, b) record stress measured in the European peripheral debt market and c) clear signs of deteriorating global growth. High yielding currencies depreciated sharply over this period while safe haven currencies rallied, lead by the Swiss franc. The policy response to a growing and widespread sense of instability was inevitable and significant. The European Central Bank (ECB) started buying Italian and Spanish government bonds, the Bank of Japan and the Swiss National Bank both took extreme measures to limit the strength of their respective currencies, and the Federal Open Market Committee (FOMC), with an unusual statement, pre-committed to keep rates at exceptionally low levels until mid-2013. As a result of these measures, the currency price action observed during the first few days of the month reversed sharply during the second part of the month, although the underlying worrying driving themes remained.
September was characterized by another sharp pick up in FX implied volatility, as the US dollar broke out of its most recent trading ranges. The US Trade Weighted Broad Dollar Index appreciated 5.6% over the month, the largest gain since September 2008. Further deterioration of global economic fundamentals, combined with persistent uncertainty stemming from the European debt crisis, sparked a sell-off in pro-cyclical and developing currencies which, until most recently, had only marginally been affected by the issues in the G3 countries. The main beneficiaries of repatriation were the US dollar and Japanese yen.
The most important currency event in September was the decision by the Swiss National Bank (SNB) to set a floor at 1.20 in the EUR/CHF exchange rate. This resulted in an immediate 10% depreciation of the Swiss franc versus all other major currencies. The competitiveness of Swiss exporters has declined significantly, as the real value of the Swiss franc has increased by almost 30% in less than 3 years and the speed of the appreciation reached irrational and unsustainable levels during the summer. The action by the SNB was therefore not really a surprise as the central bank had already made several attempts to fight the appreciation of the currency. However, verbal intervention, an increase in the supply of liquidity in the Swiss money markets, combined with foreign exchange swap operations had limited effect and failed to counterbalance the persistent demand for francs.