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June 19, 2021

Understanding Risk Sentiment

Theo Ashley-Hacker

What is Risk Sentiment?

Risk sentiment is the term used to describe how traders and investors tend to behave in different states of global economic outlook and consumer confidence. Currencies behave differently in different risk sentiments. Currencies have a 'risk off' sentiment if they strengthen in times of uncertain global outlook. For example at the start of the pandemic and in the midst of the global financial crisis.

What Determines a Currencies Risk Sentiment?

There are multiple factors that influence a currencies risk sentiment, for example if a country's central bank has a large foreign reserve and their economy is in a poor state as it often is in times of global uncertainty, they may sell some of their reserves to inject money into their economy without devaluing their own currency, consequently devaluing the currency they're selling. Switzerland and Japan are two of the highest foreign reserve owning countries and the Frank and the Yen are considered the two main risk off currencies.

Historically Japan and Switzerland have been strong during global crisis in the past and are both known for their economic stability which leads investors to favour them in times of uncertainty as they can count on somewhat more consistent economic growth

How Can You Use Risk Sentiment to Improve Your Trading?

While you shouldn't trade solely off risk sentiment, it should one of the main factors influencing your currency biases. Economies with risk off currencies tend to prefer a weaker currency as it encourage exports. The Swiss National Bank has said publicly that they intend to devalue their currency, in an interview the chairman said "We would like to live in a world where the interest rates are positive, but in the current situation negative interest rates as a way to intervene in the currency markets are essential" The SNB currently has negative interest rates. This is why you should be very weary of going long on the Frank as not only are you paying to hold the currency, but you are hedging against the Swiss National Bank.

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