Currencies likely to reflect countries' pandemic strategy success

During the height of the pandemic-induced market turmoil in March, currencies performed mostly according to how they moved with equities—their equity beta, or how risk-on or risk-off they were. That is now changing. Increasingly, currencies will start to reflect how well countries are dealing with the coronavirus pandemic. We look at which currencies could benefit from that dynamic.


Each currency can be placed on the spectrum between risk-on (cyclical) and risk off (defensive). Risk-on currencies do well when equity markets rise. The opposite is true for risk-off currencies. During 2020, this equity beta explained the fate of developed and emerging-market currencies very well. The traditional safe havens of the Japanese yen, Swiss franc and U.S. dollar were the big winners during the height of the coronavirus-induced market turmoil in March.


We believe that these defensive currencies, and especially the U.S. dollar, would have been even stronger had it not been for the intervention of the U.S. Federal Reserve (the Fed) in the form of its central bank liquidity swaps. To alleviate the global U.S. dollar shortage that emerged in March, the liquidity swaps allowed 14 major central banks to obtain U.S. dollars from the Fed rather than through private money markets. The rapid rise in the liquidity swaps—from virtually zero at the beginning of the pandemic to a cyclical high of around $450 billion in May—illustrates the difficulties that banks and other institutions had in obtaining U.S. dollars in private funding markets. The good sign is that the amount outstanding in liquidity swaps has dropped by more than half from its peak, suggesting that the U.S. dollar shortage is easing dramatically.


Since equity markets troughed in late March and money markets began normalizing, the safe-haven currencies have given up some of their gains. Within the developed market currencies, three typical risk-on currencies were among the strongest over the last three months: the Norwegian krone, and the Australian and New Zealand dollars. As it happens, these three countries have also done comparatively well in controlling the coronavirus epidemic in their countries, as measured by the rate of new infections from COVID-19.

As of July 13, 2020, the daily rate of new infections per 1 million inhabitants is 0.3 in New Zealand, 1.3 in Norway and 7.8 in Australia. In contrast, the comparable rates in the United States and Brazil are 183 and 176 respectively.1 As the world faces an ongoing fight against the coronavirus, we believe currencies will increasingly reflect not only their typical risk-on/risk-off characteristics, but also their (perceived) success in managing the epidemic.

Here are some currencies that we think could benefit:

  1. Norwegian krone. We particularly like the Norwegian krone, not only for the grip that Norway has on the virus, but also because the country has a huge sovereign wealth fund with assets close to 300% of GDP (gross domestic product) to support the economy in times of crisis.
  2. New Zealand dollar. Unlike other Western countries, New Zealand has pursued what epidemiologists call an elimination strategy, locking down its economy until the infection rate is close to zero. As that strategy has worked, New Zealand may be able to open its economy and recover sooner than other developed economies.
  3. Japanese yen. Among the defensive currencies, we prefer the Japanese yen over the U.S. dollar or the Swiss franc, as it is the cheapest of the safe-haven currencies and benefits from healthy current account surpluses. Japan also has a relatively low incidence of COVID-19 cases—although it has not entirely eliminated the virus, as New Zealand or Vietnam seem to have succeeded in doing, at least for the time being.

On the flipside, these currencies look less attractive in an environment where returns start to reflect national trends in the epidemic:

  • Peruvian sol. A less eye-catching choice than its larger Brazilian neighbour, Peru has suffered from a surge in infections and a drop in economic activity. Valuations of the Peruvian currency are not attractive enough to compensate for the economic risks from the virus fallout, in our view.
  • U.S. dollar. While the U.S. dollar is normally sought-after during crisis periods, its appeal is waning due to the current high rates of coronavirus infections in the United States and the risk of renewed lockdown measures. In addition, the greenback’s strength in recent years leaves it expensively valued. The Fed’s rate cuts have also severely diminished the dollar’s interest rate advantage against its G10 (Group of Ten) counterparts.

The euro and the British pound are somewhere in between these two camps. While both the eurozone countries and the UK have suffered a high incidence of infections during March and April, they have so far succeeded in bringing down the number of new COVID-19 cases significantly and started reopening their economies. Starting with very low historical valuations, both the euro and pound sterling have the potential to continue their recovery against the U.S. dollar over a 12-month horizon, albeit at a slower pace than in the second quarter.

To sum up, we think that currencies will increasingly reflect countries’ efficacy in managing the COVID pandemic. Two currencies that can benefit from their governments having brought infection rates close to zero are the Norwegian krone and the New Zealand dollar.

1 Source: European Centre for Disease Prevention and Control, July 14, 2020, rolling 7-day average.