The Best Risk-Off Currency Trade According to HSBC

Until recently, currency traders looking for safer investments rushed to short the Australian dollar against the greenback, however the decoupling of the U.S. dollar from the “risk on-risk off” investment environment is forcing them to look elsewhere.


With the U.S. dollar being driven by its “own idiosyncratic force”, a research report by HSBC, suggests a better risk-off trade would be to short commodity currencies like the Canadian dollar or the Aussie dollar against the Swiss franc or the Japanese yen .

Both the Swiss franc and the yen have strengthened significantly over the last 12 months, up 22 and 12 percent respectively against the dollar, driven by the sluggish U.S. recovery and ongoing euro zone debt concerns.

Of the four currency pairs (CAD or AUD vs either CHF or JPY), the bank says a short Canadian dollar-Swiss franc position provides a “slightly better exposure to the risk-off factor” than a short Aussie dollar-Swiss franc position.

The Aussie dollar, a major beneficiary of the carry trades is “extremely overvalued” according to HSBC. But the bank is recommending using the CAD instead because of bigger risks with the AUD.

One such risk includes a slowdown in China as the performance of the Australian dollar is strongly correlated to the growth in the Chinese industrial sector.

“Certainly the currency’s connection to China, which is tending to pull its breaks, has seen the Aussie dollar become a lot more volatile than what it has been in the past,” said Jim Vrondas, head of client dealing at OzForex, who sees the currency moving back towards parity.

HSBC adds that the resurgence of yen-funded carry trades also makes the Australian dollar vulnerable, particularly if Japanese investors begin to repatriate funds on a significant scale for reconstruction efforts.

On the other hand, encouraging economic conditions and prospects of further tightening in Canada suggest a positive outlook for the Loonie, which has also benefited from a recent change to the country’s political landscape after the ruling Conservative Party won its first majority government since 1988.

"We see scope for the CAD to remain strong in the coming months, with USD-CAD averaging 0.95 through the third quarter before drifting modestly higher towards year-end and into 2012," the report stated.