If there is a flight to quality in domestic markets, you should expect to see a a similar flight to quality for currency markets. What does it mean to have a currency flight to quality? There are two major flight factors which can be considered.
One, there will a flight to higher rated sovereign countries. This a relative value trade to less risky countries. Emerging market countries will be hit no different than corporate bonds. This is consistent with what we are seeing in domestic markets.
Second, there will a flight to quality based on the home bias. Investors want a premium when they invest outside of their home country for the currency risk and the uncertainty associated with distant cross-cultural investing. In this case, those countries which are net lenders will see a huge flight back to their currencies. There will also be a flight to quality to reserve currencies such as the dollar.
Enclosed is our risk appetite index which is similar to what banks have used with their research. It shows that risk avoidance has reached all time highs. The flight to currency quality this week is just a further manifestation of this behavior.
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