Sterling a safe haven? That’s only half the story
The pound is acting as a safe haven against the euro, but the evidence suggests that its ability to act as a shelter from the current crisis is polarised.
Sterling’s haven status might seem counterintuitive given that it is the currency of a country facing a slowdown exacerbated by aggressive fiscal tightening and has a central bank that has pledged to engage in a fresh round of quantitative easing. But sterling, of course, is benefiting from the fact that it is not the euro, a notion that UK prime minister David Cameron’s refusal to adopt a new fiscal pact at last week’s EU summit only underlined.
Gilts are attracting inflows, while EURGBP has broken lower through its 200-day moving average, threatening a shift as confidence evaporates in European leaders’ ability to contain the eurozone debt crisis.
Certainly, part of sterling’s resilience is based on the fact it is weak by most measures. But another part of the pound’s relatively robust performance is the notion that the British government and the Bank of England are working together to nurture a recovery in the UK economy.
Indeed, the pound barely moved after the Bank announced a fresh round of quantitative easing in October, as investors reasoned it was part of a concerted effort by the UK authorities to boost growth.
In contrast, the European Central Bank’s refusal to engage in more aggressive bond purchases has been instrumental in driving the euro lower.
|The equity neutral window in FX|
However, the pound’s performance elsewhere suggests its haven status is more nuanced. One way to define what constitutes a safe haven is to look at the long-term view – taking into account a country’s financial stability, and its fiscal, growth and inflationary outlook.
Another way, which is perhaps more relevant in today’s febrile trading environment, is to look at a currency’s short-term behaviour – that is its correlation to risk proxies, such as equities, the ease of entering and exiting positions, and its liquidity.
RBC says the easiest way to define whether a currency is a short-term safe haven is its negative correlation to risk proxies. The bank has constructed a barometer to measure this, looking at three-month correlations between daily G10 FX and equity returns.
The barometer shows that, with the exception of GBPCHF, no sterling cross lies within the equity neutral window, in which three-month correlation to equities is statistically insignificant.
That is not a typical phenomenon, says Elsa Lignos, currency strategist at RBC. Even at the height of the financial crisis, EURGBP was in the equity neutral window.
Now, EURGBP is trading as a risk proxy, indicating that as stocks fall, the pound is finding support against the single currency.
However, the full list of equity-FX correlations shows a clear pattern – that sterling still drops against traditional haven currencies, such as the dollar and the yen, in times of market stress and outperforms against higher-beta currencies, such as the Australian and New Zealand dollars.
“It looks like sterling is a safe haven for risk proxies and a risk proxy for safe havens,” says Lignos. “In other words, it is a semi-haven currency.”