A risk-off can occur when global investors’ behavior becomes more risk-averse or economic fundamentals become more uncertain. The yen has shown past historical trends of serving as a safe haven currency in times of a risk-off (2008 financial crisis, 2010 distressed European market, Japan earthquake and the Italian elections). During times of increased global risk aversion, the yen appreciates against other currencies. For example, the yen and Swiss franc appreciates against the US dollar when the US stock prices decrease and US bond prices/FX volatility increase. These safe haven currencies have low interest rates, a strong net foreign position and liquid financial markets. There are some potential cases to risk-off appreciation:
1. Driven by massive increases in financial inflows recorded in the BoP following the spikes in the VIX.
2. Spikes in the VIX are informative about the stance of the future monetary policy (for example, interest rate differentials between the safe haven currency and the US).
3. Portfolio rebalancing transactions that are not fully captured by BoP statistics (for example, derivative transactions).
Estimating the vector auto-regression (VAR) model for the “safe haven country”, the currency has shown past historical results of an upwards trend in the aftermath (the first two quarters). Yield differentials of the safe haven currency also tend to rise in the aftermath of risk-off episodes. This is because the long rate spreads between the yen and the US dollar on average widen in the aftermath of a risk-off by more than that of other currencies. Keith Knutsson of Integrale Advisors states “The yen is a perfect example of a currency to load-up on as a recessionary hedge while active investors off-load emerging market currencies.”