Strategic Currency Allocation Update

by: Daniel Zurbrügg

The main topic in the past quarter was definitively the fall of the euro, caused by severe debt problems of some of its member states, primarily Greece, Portugal, Italy and Spain. But there were other interesting developments as well, such as China’s announcement regarding its future currency policy and Russian’s central bank stating that they would further diversify their currency reserves away from the US dollar and euro into currencies such as the Australian and the Canadian dollar.

This is not a new situation, the need to diversify reserve holdings and therefore lessen the dependence on the US dollar was discussed in the early 1980s already. However, once the US dollar started to appreciate and entered a longer-term upward trend in the 1990s, these concerns quickly faded. This time is different. In the 1980s there weren’t too many real alternatives to the US dollar. Also, many countries did not even have freely floating exchange rates. It was still pretty much a bi-polar world, with the US being the dominant pole. However, today this is changing and investors have more and more options to diversify currency holdings, even if they do not consider the euro to be a real alternative.

But what currencies can become an alternative? In one of their latest studies, the economists of Barclays have looked at what currencies might become the best alternatives for diversification and therefore what currencies are most likely going to be used by central banks in the future. The economists looked at six key criteria: Diversification, liquidity, efficient capital markets, freely tradable currency, stable economic and legal framework and expected value preservation. The study found that the Australian dollar and the Canadian dollar seem to be the best alternatives, with the New Zealand dollar and the Swedish and the Norwegian crowns being good alternatives as well. We continue to like these currencies because the currency diversification by investors and central banks is going to continue and will therefore continue to support a structural appreciation of these currencies.

One of the strongest currencies in Q2 was the Swiss franc, which has been strong against the euro and the US dollar. After initially jumping to a level of 1.18 versus the US dollar, the Swiss franc started an impressive rally, which brought USD/CHF back to the 1.05 level. The main driver behind this has been the impressive move in EUR/CHF, which came under pressure after it became obvious that the Swiss National Bank would not continue to weaken the currency and let it appreciate. The euro remains the most important currency for Swiss export companies. Levels between 1.50 and 1.60 were seen as target levels for the Swiss National Bank for a long time, but market forces continued to push Swiss franc higher. Now that the euro became so weak, primarily caused by the debt problems, the key support levels at 1.50 were no longer realistic and EUR/CHF finished the quarter at 1.33.

Disclosure: No positions