Articles

Risk sentiment and its impact on currencies

By Erin Harding April 8th, 2022

The war in Ukraine has been driving the currency markets for weeks now. When reading about it, you may have encountered the terms ‘risk sentiment’ or ‘risk-on risk-off’. But what do these terms mean for currencies?

What is risk sentiment?

‘Risk-on risk-off’ or ‘risk sentiment’ refers to investor’s appetite for ‘risk’. It is sometimes also referred to as ‘risk sentiment’ or investor sentiment.

A low-risk environment is described as ‘risk-on’. A ‘risk-on’ situation is likely to occur during times of market stability or recovery. This allows investors to opt for ‘riskier’ assets, such as currencies like the Australian or Canadian dollar.

If the risk is perceived to be high, this is described as ‘risk-off’. A ‘risk-off’ environment is likely to occur during times of instability. This could be caused by events such as the Ukraine war, which prompt investors to err on the side of caution and opt for safer assets. These assets could be ‘safe-haven’ currencies such as the US dollar or Japanese yen.

How have the pound and euro been impacted by ‘risk-on risk-off’?

Typically, sterling would weaken in a ‘risk off’ environment and strengthen during ‘risk on’. However, in a ‘risk-off’ environment it can weaken against ‘safe-haven’ currencies, which we have seen with its recent losses against the US dollar. It can also strengthen against ‘riskier’ assets, such as emerging market currencies. We have recently seen the pound strengthen against the euro in ‘risk-on’ situations.

In recent years, the euro has started to behave more like a ‘safe-haven’ currency, strengthening in times of market volatility.

This is not always the case, though. As the crisis in Ukraine has escalated, the euro has weakened against the pound. This is because the crisis and sanctions on Russia have a direct effect on the European economy. Europe is reliant on Russian gas and energy.

Why are certain currencies deemed ‘safe-haven’ or ‘risk-sensitive’?

A ‘safe-haven’ currency is usually considered as such if it has a stable economy behind it. For example, the Swiss Franc is a safe-haven currency due to factors such as the stable Swiss government, safe banking industry and low unemployment. The Singapore dollar’s safe-haven status has grown in recent years, benefitting from being the only southeast Asian economy considered to be developed rather than emerging.

In contrast to this, the Australian dollar is a risk-sensitive currency, as it is strongly tied to commodities. This is because Australia’s economy is heavily reliant on the export of agricultural and mining products. These commodities are volatile and demand from Asia tends to impact the Aussie dollar.

Similarly, emerging market currencies, such as the Russian ruble and Brazilian real tend to be ‘riskier’ due to the Russian and Brazilian economies’ heavy reliance on commodities and bouts of political instability.

How can you protect your business from currency movements?

Although the pound strong against the euro at the moment, it’s impossible to predict how it will fare in the coming days and weeks. In these uncertain times, it’s wise to protect your business from volatility. Call us now on 020 7898 0500 or email us on info@smartcurrencybusiness.com.