Has the financial crisis changed investor perceptions about safe havens? Christine Senior looks at the question in the FX context

Over the past couple of years perceptions of financial safe havens have changed in the wake of global financial stress. Traditional views about financial strength and stability have been turned upside down. Historically, volatile emerging markets have weathered the turbulence more effectively than the normally more stable developed world. Questions remain over the long-term status of the US dollar against a background of economic uncertainty, while emerging economies continue to remain strong.

This year the three traditional safe havens of US dollar, Japanese yen and Swiss franc are still riding high, with minor hiccups. The US dollar, after coming under some pressure, still looks impregnable, in spite of the US government's apparent unwillingness to take the tough measures needed to get its economy back on track.

"Investors have come to the view that the US government will continue to throw off deficits - but that, even so, there is enough flow coming from surplus countries, towards US Treasuries in particular, to support the currency," says Sunil Krishnan, a portfolio manager in BlackRock's multi-asset client solutions group. "Would it be a concern if the US continually fails to put its house in order? Probably only if it starts to look as though other problem countries have done a much better job. Fiscal consolidation takes many years, so that doesn't look like a theme for the next six to 12 months."

But another trump card for the US currency is the lack of suitable alternatives. The world's largest economy, the engine of global growth, is recognised as strong and stable with a liquid market and a plentiful supply of investable vehicles.

"People struggle to see how the current main providers of inflows to US treasuries can divert such large quantities of money to anything else," adds Krishnan. "It's hard to see other markets which are as big and as liquid. That is what I think has continued to support the idea of the dollar being a defensive asset."

The Swiss franc is also continuing to maintain its role as one of the traditional triumvirate of safe havens. It has benefited from concerns about the weakness of the euro, but suffered repercussions from the banking crisis in 2008 as the Swiss banking system was also tainted, and for a period failed to match the strength of the dollar or yen. Another driver of its strength has been its use as source of funding for longer-term investments, including mortgages by Eastern European investors. One factor that has somewhat taken the gloss off is the belief that the Swiss National Bank is more likely to intervene to restrict inflows of currency.

As for the yen, its status as a safe haven stems in part from its importance in the carry trade. Investors have used the low-interest yen to fund investments in other currencies offering higher returns. In times of stress, investors who borrowed in yen closed their positions, moving back to the Japanese currency. Now that low interest rates are the norm elsewhere, the yen has lost its advantage and will not necessarily be the chief beneficiary of unwinding carry trades when trouble strikes again. Certainly the performance of the Japan's economy is no incentive to investors to park their money there. But a high current account surplus and the fact that most investment in government bonds is held by domestic investors minimises the risk to the currency.

"Unless there's a big policy change by the SNB [Swiss National Bank] or Bank of Japan, which would involve trying to weaken their currency and would mean some very aggressive foreign exchange intervention - which the Bank of Japan is reluctant to do and the SNB have tried and given up - then I think these currencies will remain the safe havens that people will go to in times of market stress," says Dale Thomas, head of currency management at Insight Investment.

So what of the other traditional bolt hole in times of crisis - gold? At the start of the credit crisis in 2007 gold rallied as investors piled in amid government interventions to prevent the collapse of banks. But after the bailout of Bear Stearns, gold lost its lustre. Its value dropped, offering investors no protection. "The correlation between gold and risk assets is not stable in times of real stress," says Thomas. "Gold will probably suffer in line with other metals."

As a hedge against inflation, gold has some value, although other assets might be equally useful. Jerome Booth, head of research at Ashmore, backs the view that gold has no real value as a safe haven: "Gold is non yielding, it's not particularly useful for anything else and worst of all it has a very homogenous investor base - it's dominated by central banks. Gold is a highly speculative investment."

Emerging market currencies are raising their profile as potential safe havens. These economies are recognised as the future drivers of the global growth, and their markets have tended to survive the financial crisis relatively unscathed compared with those of the US and Europe. Their governments have stronger balance sheets and their central banks are the major holders of US Treasuries. The volatility of emerging market currencies on the whole has been lower than their developed market counterparts.
Booth says currencies of major surplus countries in the emerging markets - China, India, Indonesia and Brazil - look the most likely to appreciate over the longer term.

He backs a diversified mix of EM currencies to provide a medium-term safe haven. "I would go so far as to say a portfolio of emerging money markets - that is, very short-dated instruments like treasuries but with emerging market currency exposure - is the safest asset class in the world. It is safer than US Treasuries, because that has dollar risk; safer than the euro-zone equivalent; [and] safer than gold because it is cash but in currencies that are likely to go up."

Still, there is the feeling that the time for emerging market currencies is yet to come: "I don't think the emerging market currencies are in a position to challenge the major safe-haven currencies, the dollar, the yen, and the Swiss franc," says Thanos Papasavvas, head of currency management at Investec Asset Management. "But the emerging market currencies are seeing a shift in investor perception as being more stable."

One emerging market currency that could in future be a potential replacement for the dollar is the Chinese renminbi. For the moment it is not fully convertible and so is an unlikely contender for safe-haven status. But on an objective basis over the longer term, representing, as it does, the fastest growing economy in the world, it looks set to achieve investor acceptance. Recently, the Chinese government has taken some initial steps that could eventually lead to the currency becoming internationally convertible. In June it allowed Chinese exporters to use the renminbi to settle their trades with the rest of the world and introduced a more flexible valuation mechanism. This was followed by the establishment of Hong Kong as the official renminbi offshore centre. At the same time deregulation of renminbi transactions in Hong Kong allowed local investors to invest in renminbi bonds, paving the way for the potential launch of other renminbi products.

How long it will take for the currency to turn into a safe haven depends on how quickly renminbi deposits in Hong Kong grow and how many investment products are available, says Victoria Mio, manager of a Chinese equities fund at Robeco Asset Management in Hong Kong. "China's trade flow with the rest of the world was worth $2.2trn in 2009, with exports of $1.2trn and imports of $1trn," she observes. "If 10% is settled in renminbi you are talking about $220bn. If investors can get hold of that it can become a safe-haven currency."

But others are less optimistic about the future course of the renminbi as an international currency. China's whole economic system is based on government control of the banking system and currency, which it uses to stimulate areas of the economy it wishes to. Changing that would need a complete turn-around of government policy.

Jonathon Griggs, head of quantitative FX strategy at JP Morgan Asset Management, feels the Chinese currency will not achieve safe-haven status for perhaps 20 years or more, and certainly remains way behind the US in its attractiveness to investors. "China doesn't have a fully convertible currency, the economy is still export led, domestic demand is picking up but is nowhere near being the driver of global growth, and the policy environment is relatively opaque," he says.

The Australian dollar, the Canadian dollar and the Norwegian kroner have also been touted as potential safe havens, but largely dismissed through their susceptibility to the ups and downs of commodity demand. Values face volatility linked to Chinese demand for commodities, or prospects for the US economy in the short term. Another hurdle is their limited size. None has major debt markets, so they could never absorb large-scale demand from investors.

Of course the big loser in the past few months has been the euro, which has taken a mighty battering. Once considered a potential rival to the US dollar as a reserve currency, it remains widely held just by virtue of its importance to world trade. Once investors might have considered all euro-zone debt was similarly risky but that view has now been comprehensively scotched. The economies in the euro-zone are very different. What has become apparent is that the euro-zone is a collection of sovereign states with one currency and one monetary policy, whose members will support each other, albeit reluctantly, in times of stress.

"The suspicion is that big holders of euro assets - Asian reserve managers - that have accumulated huge amounts of reserves and lots of debt, have been selling their non-core, non-French and non-German government debt, and not replacing it with German or French debt," says Thomas. "There is a real problem that there isn't much short-dated German government debt around, so you have now a situation where the euro doesn't have a savings asset market."

Apparently seismic shocks to the global financial system might have been expected to lead to equally seismic changes to the market's perception of its safe havens. While there is some evidence of the beginnings of that process, experience so far suggests that the timescale may be geological in the longer-term sense.