Why aren’t traditional haven assets behaving like they should in times of turmoil any longer?
The yuan is increasingly exhibiting haven characteristics underpinned by China’s huge current account surplus and foreign reserves, and gaining in value during recent periods of geopolitical turmoil
Is there safety in safety?
The propensity of international investors to seek out so-called “haven assets” during periods of turmoil in financial markets is as old as the hills.
Traditional safe haven investments have included cash, gold, the government bonds of the most creditworthy countries, the currencies of the world’s largest economies and, following the global financial crisis, the assets of some emerging markets, notably in Asia.
While there is no such thing as an asset offering absolute safety, havens are usually defined as assets that are favoured in times of uncertainty because of their perceived stability, liquidity and steady income streams. This is because their performance, in the words of the International Monetary Fund, “correlates negatively with [the returns] of riskier assets during times of stress.”
Yet the haven status of assets, which were once reliable refuges for investors during periods of turbulence, was turned on its head after the financial crisis and has been in an even greater state of flux since the world’s leading central banks, led by the US Federal Reserve, began to unwind their ultra-loose monetary policies.
The clearest example of this is the wilting US dollar.
Once the most reliable haven currency along with the Japanese yen, underpinned by the greenback’s status as the world’s reserve currency, the dollar stopped behaving like a haven in 2014, according to Bank of America Merrill Lynch. This is partly because its role as the main funding currency – a low-yielding currency that investors sell in order to invest in a higher-yielding one, a strategy known as the “carry trade” – has been supplanted by the euro and the yen as US interest rates rise and Europe and Japan maintain their ultra-accommodative monetary policies.
Other reasons why the greenback, down 12 per cent since January 2016 according to the dollar index (a gauge of its performance against a basket of other currencies), has lost some of its haven appeal include America’s hefty current account deficit – both the euro zone and Japan enjoy significant surpluses – and, more worryingly, the increasingly protectionist and nationalist policies of President Donald Trump’s administration.
Government bonds, another traditional haven, have also become riskier investments.
A decade of aggressive quantitative easing has created severe distortions in sovereign debt markets, reducing liquidity and calling into question the suitability of bonds in mitigating risks and stabilising investors’ portfolios.
The clearest example of this is Japanese government bonds, the world’s second-largest sovereign debt market. The country’s central bank now owns a staggering 40 per cent of JGBs, leaving fewer bonds for investors to buy and sell. Liquidity has dried up to such an extent that last Tuesday not a single benchmark 10-year JGB was traded in the secondary market. A haven with a dearth of buyers and sellers is not much of a haven.
Just as worryingly, central banks’ QE programmes have driven up the prices of sovereign bonds to dangerously high levels, thereby pushing yields down and increasing bonds’ vulnerability to a rise in inflation and the removal of monetary stimulus.
According to data from JPMorgan, nearly 20 per cent of the global stock of sovereign and corporate bonds trades with a yield below zero, with almost 30 per cent of European debt trading in negative territory.
Not only does this mean that the buyers of these supposedly safe assets are guaranteed to lose money if they hold the bonds to maturity, even moderate increases in inflation and interest rates will leave investors nursing heavy losses.
All this has led to what Goldman Sachs rightly calls “diversification desperation.”
During last month’s “mini-crash”, when volatility surged and the benchmark S&P 500 equity index suffered its sharpest daily decline since 2011, traditional havens failed to act as havens. As stocks plummeted in early February, none of the typical refuges, including gold, rose in value, depriving investors of effective hedges to reduce volatility by diversifying their portfolios.
This begs the question: are there any bastions of safety in markets?
Some currency traders believe the yuan has started to exhibit haven characteristics, underpinned by China’s huge current account surplus and foreign reserves, and gaining in value during recent periods of geopolitical turmoil. Yet the yuan’s resilience owes much to the slumping dollar and Beijing’s capital controls – a definite no-no for traditional havens.
The most reliable sanctuary from nervy markets still appears to be the yen, given its status as one of the most actively traded currencies, bolstered by Japan’s long-standing position as the world’s largest creditor nation. Not only did the yen rise sharply during the global financial crisis, it has been strengthening of late, partly in anticipation of the end of QE.
In a world of increasingly unreliable havens, this is about as safe as it gets.
Nicholas Spiro is a partner at Lauressa Advisory