Which safe-haven currency will benefit most?

Tamawa Desai
Reuters

Risks of global economic slowdown have triggered a shift toward “safe-haven” assets this month, pushing world stock prices off their peaks and bond yields to multi-year lows.

Concerns about heavily indebted peripheral euro zone countries have also resurfaced, souring sentiment. Currencies perceived to be conservative “safe-haven” bets have traditionally included the dollar, yen and Swiss franc. They are sought by investors during market turmoil as they are deemed as having ample liquidity with solid economies backing them.

So which currency stands to benefit the most in the current situation?

WHY THE SWISS FRANC WOULD GAIN THE MOST

There are fewer obstacles to buying the franc after the Swiss National Bank (SNB) effectively abandoned franc-selling intervention in June.

In contrast, Japanese authorities are upping the ante after the yen hit 15-year peaks against the dollar last week.

And there are risks of the dollar’s value eroding on the possibility of more U.S. monetary easing.

Positioning is now neutral for short-term Swiss franc positions, indicating room for a further upward swing, said UBS currency analyst Beat Siegenthaler.

“What is striking is as of last week all longs seemed to have been squared, meaning that investors were broadly neutral on the franc for the first time since early 2009,” he said.

Switzerland weathered the global economic downturn better than other European countries and the central bank expects growth around 2 percent this year.

Economists are divided when the central bank may raise its interest rate target, currently at a rock-bottom 0.25 percent. Interest rate futures point only to an increase in mid-2011, but given buoyant domestic conditions both UBS and Credit Suisse see an increase in the second half of 2010.

The Swiss unit rose to a one-week high of 1.0348 franc per dollar on Monday, and traders say the January high around 1.0130 francs is in sight.

YEN TO COME A CLOSE SECOND

The yen is widely used as a funding currency for leveraged carry trades since interest rates in Japan are at near zero levels and are unlikely to rise anytime soon.

But when doubts about a global recovery gather pace, those leveraged positions are unwound, boosting the yen, currently trading near a 15-year high against the dollar. Those gains came as U.S. Treasury yields moved sharply lower on growing doubts about a U.S. recovery.

Its recent strength has led to speculation that Tokyo could intervene to check gains. Its last such move, in March 2004, ending a 15-month campaign to stem the yen’s rise.

The threat of intervention along with overstretched positions will slow the yen’s ascent, traders say. But any impact from intervention or otherwise could prove to be fleeting as the yen grinds toward to its record high of 79.75 per dollar hit in 1995.

“Any attempts by the authorities to weaken the yen will prove fruitless on a medium-term basis,” said Richard Grace, chief currency strategist at Commonweath Bank of Australia.

WHY THE DOLLAR WOULD LOSE OUT

Investors may find it hard to buy the dollar as long as the U.S. Federal Reserve leaves the door open for further monetary easing, as falling bond yields reduce the appeal of U.S. assets.

The dollar index, which tracks the performance of the greenback versus a basket of six other major currencies, fell 5.3 percent in July .DXY.

It has come off peaks seen in mid-June as U.S. data continued to disappoint, and as expectations for monetary tightening were dashed after the Fed gave a more downbeat economic view at its latest meeting.

“With so much uncertainty, especially regarding Fed policy, it is best to remain defensively positioned,” said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi UFJ. “More quantitative easing by the Fed would significantly reduce the appeal of the dollar.”

The dollar could also be hurt if attention turns to the size of the massive U.S. fiscal deficit.

Moody’s Investors Service said on Tuesday the top AAA sovereign ratings of the United States, among others, were well positioned but face new challenges that increase the possibility of a downgrade. It noted the United States had yet to come up with a credible plan to shore up its finances.

(Additional reporting by Catherine Bosley in Zurich; editing by Patrick Graham)