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Derisking risk currencies: looking for the new safe havens

Country risk is an easy explanation for a successful deal; risk-on or risk-off can ostensibly explain all kinds of market gyrations in the niche currencies. But good old-fashioned credit quality is more important.

When is a risk currency not a risk currency? The market is used to regarding commodity currencies like the Canadian and Australian dollar as risky plays. With risk appetite at home, comes risk appetite abroad. Consumption of commodities should slump with a core-currency recession, and capital flows home in times of trouble.

The performance of niche currencies has faithfully followed this pattern. The Australian dollar slid more than eight cents against the dollar in May — almost 10% of its value. On May 26, as Greece considered privatising its assets, the EU and IMF debated stepping in, and National Bank of Greece reported 93% decline in profits, the Canadian dollar touched bottom.

On some measures, this seems surprising. Canada and Australia have every wish list characteristic of a safe haven — stable financial systems with healthy banks, governments with healthy finances, stable democratic political systems with respect for private property, and free movement of capital.

It’s true that the macro environment in both countries is heavily tied to larger neighbours. China is Australia’s largest trading partner, taking 21.6% of Australia’s exports in 2009. Canada is even more heavily tied to the US, which takes around 73% of its exports. But neither neighbour is a southern European nation with fiscal consolidation issues.

Since the markets began to focus on sovereign risk in the eurozone, investors have piled into dollar bonds and US risk. But they have shied away from buying Canadian dollars. For Australia, one might expect that 10% growth in the country’s largest trading partner and probable rate rises might make Aussie dollars attractive to safe haven investors.

Indeed, when Australian or Canadian bond issuers come to market the safe haven logic seems to apply. From this point of view, investor enthusiasm for Australian and Canadian risk has helped a string of issuers, including Canadian provinces and Australian banks, printed tight deals in the euro markets, across currencies from Swiss francs to dollars to euros to Norwegian krone.

So why not in FX? Trade balance figures set FX rate expectations, and trade balances in Australia and Canada are heavily influenced by commodities risk. But FX is only one way to buy into a country, and not necessarily the best.

For fixed income investors, there is a difference between country risk and credit risk. Fixed income investors are not buying Australian risk or Canadian risk — they are buying individual bonds supported by healthy public finances and sound banking systems. Province of Ontario or Commonwealth Bank of Australia are good credits because their finances are on sound footings and investors expect full repayment, not primarily because of their countries of residence sell a lot of coal and oil into the international market.

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