August 9th 2011: Analysis - Looking for a safe-haven as markets panic
As equity markets enter panic territory, there will be frantic search for safe-haven currencies and the list of candidates is depressingly short. Ironically the dollar in a strong position for now despite its very obvious shortcomings. The US Treasury market will continue to be the ultimate safe-haven market despite Standard & Poor’s credit-rating downgrade. There is no other market which comes close in terms of liquidity and the ability to trade is a vital component in these extremely turbulent conditions.
Although the US has been an important cause of the current panic, the dollar will gain support in the very short term, especially if credit markets seize up. It will be difficult to gain strong backing as the fundamentals continue to deteriorate. Once the panic subsides, then the dollar will become vulnerable to heavy selling again and a move into the Swedish Krona looks a solid strategy. The Canadian dollar will also offer good value if it retreats to beyond 1.05 against the US unit
The yen and Swiss franc will continue to gain near-term support and there will be defensive flows into these currencies. The fundamentals here, however, will look increasingly vulnerable and there will certainly be unease over the Swiss banking sector which has huge liabilities. On valuation grounds it is also extremely difficult to justify parking funds in these currencies and intervention will be used to counter further gains.
The Euro-zone structural vulnerabilities remain a key market focus with the ECB buying some time through the purchases of Italian and Spanish debt. The Euro-zone economic outlook will deteriorate rapidly in the short term and this will make German insistence on austerity measures even more damaging for the peripheral economies. The internal logic still dictates that the Euro needs to break up into two areas. If it survives, there will be a strong case for buying the new ‘hard Euro’, but not at these levels.
Sterling has some success in portraying itself as a defensive asset over the past few weeks. The UK is outside the Euro-zone which will give it important protection and the government has started to tackle the budget deficit. The UK economy, however, is extremely vulnerable to a renewed downturn and the banking sector will come under severe stress over the next few weeks. The most likely outcome is that the UK economy will be swamped by the global downturn. With rioting in 3 major cities, the political backdrop is increasingly unfavourable and the more likely outcome is that Sterling will come under heavy selling pressure.
Commodity-linked currencies have come under heavy selling pressure as stock markets have crashed with the Australian dollar already weakening back through parity while the Canadian currency is currently flirting with this pivotal level. In times of market stress, these currencies will never be seen as safe-haven material, especially if there is a deterioration in credit conditions and a downturn in Asia will also have an important negative impact on the Australian currency. Once the dust settles, the Canadian dollar will offer attractions given the sound fundamentals
Emerging markets generally have performed extremely strongly over the past few months, but the lack of liquidity always makes them extremely vulnerable when risk appetite deteriorates. The Brazilian real has weakened sharply and there will be further near-term selling pressure, especially with the threat of margin calls and forced selling.
Chinese equity markets have already fallen sharply from their peak which may make them less vulnerable to further selling, but the Chinese economic is about to take a dive as leveraged borrowers collapse amid a deluge of bad debts and corruption. In this context, Asia as a whole is best avoided at this stage.
Norway and Sweden have generally attractive fundamentals. Although Norway will be unsettled by the decline in energy prices it has a massive external surplus and these currencies remain the most attractive of the ‘second-tier’ currencies, especially as they are not in danger of losing their AAA credit ratings.
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