Why the idea of ‘safe haven’ is undergoing a shake-up | Mint

Why the idea of ‘safe haven’ is undergoing a shake-up

The decoupling of gold and interest rates does not signal a decline in its safe haven status. A likely explanation is that the impact of future rate hikes has already been factored into gold prices. (Image: Pixabay)
The decoupling of gold and interest rates does not signal a decline in its safe haven status. A likely explanation is that the impact of future rate hikes has already been factored into gold prices. (Image: Pixabay)

Summary

  • As the world lurches from one crisis to another, the notion of what is a safe asset is shifting in subtle ways. The dollar is not prepared to take on inflation, gold’s conventional relationship with interest rates is under challenge, and the yen has weakened since 2022. What lies ahead?

In financial markets, a safe haven is an asset that retains its value through war, calamities, economic troubles, or other disasters. Historically, gold and US government bonds have been considered the safest of assets. In currency markets, the Swiss franc and the Japanese yen—along with the US dollar—are the usual safe havens. But as the world lurches from one crisis to another, and geopolitical tensions ratchet up, the notion of what is a safe asset is shifting in subtle ways.

Consider the dollar, the dominant reserve and trading currency with unparalleled global liquidity. Unfortunately, while the dollar hedges well against geopolitical risk, it does not offer much protection against inflation. In September 2023, US retail inflation was at 3.7%, about half the 8.2% recorded a year ago, but still far from the 2% target rate. The ongoing conflict in West Asia has re-introduced inflation risk by pushing up oil prices.

(Graphics: Mint)
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(Graphics: Mint)

US government bonds are preferred in times of economic uncertainty or market volatility, but recently, Treasuries themselves have become unstable. Yields dropped for some time after the Hamas’ attack on Israel, but concerns about massive government borrowing, expectations of higher-for-longer interest rates, and front-loaded issuance of longer-dated securities made markets so jittery that the 10-year yield briefly went past 5%. Hints of a drop in foreign demand (notably, sell-offs by China) and negative tweets by hedge fund managers have also triggered bouts of volatility. That, and the rise in treasury yields, have somewhat tarnished the image of the world’s benchmark risk-free asset.

Gold paradox

Gold is a hedge against inflation as well as geopolitical risk. Not surprisingly, gold prices have been on a bullish trend. Until May 2023, US rate hikes were a key price trigger, as higher interest rates increase the opportunity cost of holding gold. But this negative relationship has become less powerful in recent months. Between May 2022 and May 2023, as real rates rose from negative levels to 1.4%, the price of gold increased by nearly 8%. By October 2023, yields had shot up to 2.4%, but gold prices remained stagnant, despite heightened geopolitical tensions.

The decoupling of gold and interest rates does not signal a decline in its safe haven status. A likely explanation is that the impact of future rate hikes has already been factored into gold prices. In fact, gold demand remains strong, driven by consumer demand in Asia as well as purchases by central banks, which are keen to include gold in their reserves.

Currency shopping

The yen and Swiss franc are popular safe haven currencies. The yen has weakened since 2022 mainly because of the Bank of Japan’s contrarian policy of low interest rates and yield-curve control. A slow reversal of policy has already pushed up yields, and this in turn, is likely to attract capital inflows and strengthen the yen. Additionally, authorities are expected to intervene if the yen falls too far below 150 to a dollar. Either or both events could increase market volatility and upend the yen-based carry trade.

The Swiss franc, in contrast, is strengthening, though not entirely on account of being a safe haven. Since June 2022, the Swiss National Bank (SNB) has intervened to support the franc and control imported inflation—without this the currency would have been weaker. The current climate of geopolitical risk favours the franc, but weakening pressures may build up once inflation cools and the SNB stops intervening.

Last asset standing?

A May 2023 Bloomberg survey suggested that investors would favour bitcoin over the dollar, yen and Swiss franc in the event of a US debt default. Crypto assets have become more widely acceptable for two reasons. First, the belief that quantitative easing has eroded fiat currency and high levels of national debt could result in more money printing have led some to conclude that bitcoin will be the last asset standing when conventional policies fail. Second, traditional fund managers are endorsing crypto hoping for a launch of bitcoin exchange-traded funds. BlackRock’s Larry Fink described the recent bitcoin rally as a “flight to quality"; brokerage firm Bernstein went so far as to label it a safe haven. Clearly, some investors view bitcoin as a robust store of value. But for the rest, it remains a highly volatile and controversial asset, and regulators globally advise caution against it.

The author is an independent writer in economics and finance.

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