Difference between Risk and Safe Haven Currencies

When reading the daily forex updates one of the most commonly used terms are safe haven currencies and risk currencies. This is nothing but a distinction on whether a currency is considered to be risky or safe, thus the terms are used for reference. The terms safe haven and risk currencies in fact have nothing to do with how safe the value of the currency is. The terms are only used as reference in a way how a currency reacts to the markets.

There is a distinction between the risk v/s safe currencies and it is important to understand this fact. When a currency pair is considered to be risky or safe is determined by how it co-relates to other assets. To illustrate, when risky assets increase it is always best to buy.

Similarly when risk prone assets fall, it is better to sell such pairs. When a divergence in that correlation is noticed or in other words if a risky or safe currency pair is not moving in the same direction as other similar or relative assets, then it indicates early signs for a change in direction for those assets and the currency pair.

Risk currencies behave the same way as risk prone assets such as for example stocks or commodities such as oil, gas and so on. Risk prone assets rise when markets are optimistic and fall when the markets are nervous. In other words risk prone assets are quite volatile and subject to market conditions.

Contrary to risk prone assets, Safe currencies or safe haven currencies behave in the opposite way. Some example of safe haven assets include investment grade bonds which tends to increase in alue during times of uncertainty and falls when the markets are optimistic.

To illustrate this, in the present scenario if you consider the Canadian Dollar which is known to be a risk prone currency. But in reality, Canada’s strong economy and a healthy banking system makes the CAD infact one of the safest currencies for long term value.

Factors that influence the risk or safety element in a currency

The biggest factor that influences if a currency is safe or risky is Yield. Assets that have a high short term interest rates as well as those assets that are expected to attract higher interest rates in the future often move alongside risk assets, this is because such assets are used mostly in carry trade. Carry trade is nothing but purchasing high yield currencies which are funded by selling low yield curencies and making profits on the difference of the interest rates. Learn more about carry trade strategy here.

Besides yield, other factors that contribute to influencing the risk or safety element in a currency are export based economies and their relative currency. Such currencies tend to react in the same way as risk prone assets.

List of Currencies that are considered Risky

Safe haven: CHF, USD, JPY

When risk assets are on the rise, traders typically get one of the following:

Long pairs, which has a base currency higher on the risk scale than the quote currency. Example: AUD/JPY or EUR/USD.

Short pairs, which has a base currency lower on the risk scale than the quote currency. Example: GBP/AUD or EUR/NZD.

When risk assets decline, traders typically do the opposite to the above.

The above example is only for generalization and seldom works perfectly for a given period. Currency specific news items often make currencies to behave out of order from the list above.

Example: Even if markets seem pessimistic, if there is bad news for the Japanese Yen, it may not be trading strong during that day despite the fact that the market is in a “safe haven” mode. Conversely, in times of market optimism, the Aussie dollar could under perform the other risk currencies influenced by specific events or conditions. Factors such as slow growth or sinking expectations in regards to interest rate increases in Australia or maybe bad news about the economy of its biggest export customer, China.

List of Currencies that are considered Safe Haven

When markets are anxious, the JPY, USD and CHF are considered to be strong in the order. During times of pessimism, traders usually try to short the following pairs: AUD/JPY, AUD/CHF, AUD/USD, NZD/JPY, NZD/CHF, NZD/USD, EUR/JPY, etc.

Currency-specific events can cause currencies to perform in contrary to their risk or safety ranking. For example, over the past years the CHF has, in fact, been the preferred safe haven, due to Switzerland’s stronger economy and lower debt levels, compared to the US and Japan. However, when there is great fear about Europe’s economy, the CHF may weaken.

Central bank interventions, meaning attempts to make their currency cheaper in order to help exporters, can also cause currencies to perform differently than what their risk ranking would suggest.