FX Alpha 03 September 2013

The end of Risk on – Risk off

Although all eyes are focussed upon current account risks in emerging markets, within the G10 complex there has been a complete breakdown of the risk on – risk off regime

Over the last 6 years investors in G10 have become used to the risk on – risk off trading regime where higher yielders outperform during periods of increasing risk appetite whilst lower yielding currencies tended to depreciate and vice versa. What is notable is that there was little differen-tiation of such currencies along fundamental lines; higher yielders simply appreciated en mass, while lower yielding currencies lost ground. The cause of this dynamic lay with central bank liquidity policies. By flooding markets with abundant liquidity and effectively mitigating tail risks (think of the ECB’s LTRO policy) volatility term structures flattened to lower and lower levels with consequent appreciation of higher yielding currencies. Investors did not have to concern themselves with differentiation. Until now that is.

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