Risk-on, risk-off: how the market mood impacts your exchange rate
Investor risk perception prompts risk-on and risk-off currency market conditions. This reflects how investors navigate risk-sensitive and safe-haven assets amid political and economic uncertainty. Discover how these shifts in market sentiment impact exchange rates.
Exchange rates reflect the balance of investor risk perception amid political and economic events. Market sentiment and appetite for risk influence how currencies behave as investors adjust their exposure to risk-sensitive or safe-haven assets. This is referred to as ‘risk-on’ or ‘risk-off’, or RORO.
‘Risk-on risk-off’: what does it mean
Risk-on or risk-off – also referred to as risk sentiment or investor sentiment – refers to investors’ appetite for risk when trading currency, an essential process that determines exchange rates.
When risk is considered low by investors market conditions are referred to as risk-on. This is characterized by a period of market stability or recovery. These conditions allow investors to purchase riskier currencies like the Australian or Canadian dollar.
When risk is considered high by investors market conditions are referred to as risk-off. This is characterized by a volatile or uncertain environment during times of instability, such as a global conflict. The events that prompt a risk-off market mood typically cause investors to react cautiously and opt for ‘safe-haven currencies such as the US dollar.
The pound’s relationship with risk
Typically, a risk-off market mood causes the pound to weaken, while risk-on causes it to strengthen.
For example, escalation of military conflicts or indicators pointing to an economic slowdown or recession in major economies – notably the US and China – can trigger an investor flight to safety. In these scenarios, the market mood would be described as risk-off. The pound is likely to weaken against safe-haven currencies like the US dollar, and to a lesser extent euro, which typically strengthen in this environment.
The euro’s relationship with risk
The euro has a less predictable relationship with risk sentiment than the pound. Traditionally, it reacted like the UK currency: strengthening during periods of market stability or optimism (risk-on) and weakening during periods of market uncertainty (risk-off).
More recently, however, it has adopted the characteristics of a safe-haven currency, strengthening during periods of market volatility when the market mood is risk-off. The pound euro (GBP/EUR) exchange rate, therefore, typically softens amid these conditions.
This downward movement isn’t guaranteed, however, as demonstrated by the events in Ukraine. As the crisis escalated, the euro declined in value, despite the pound being more sensitive to risk, because it directly impacted the European economy.
Safe v risky currencies
Safe-haven currencies are usually supported by a robust economy, such as the Swiss franc which is reinforced by a stable government, safe banking industry and low unemployment. The US dollar’s status as the world’s reserve currency means it’s often the default safe-haven choice during periods of uncertainty, instability and volatility.
Meanwhile, as a commodity currency, the Australian dollar is sensitive to risk. Australia’s economy is dependent on the export of volatile agricultural and mining products, with demand from Asia impacting the currency.
Other risk-sensitive currencies include the Norwegian krone, Russian rouble and Brazilian real.
How to protect your overseas property purchase from currency movements?
Risk sentiment is dynamic amid the unpredictable economic and political variables that influence it. This uncertainty can stoke pound volatility, potentially impacting the price of your overseas property.
A currency specialist can help you tailor a strategy that ensures your property buying budget is shielded from this potential volatility. This might include using a forward contract to lock in an exchange rate for future transactions and stop unpredictable economic variables from driving up the costs of your overseas property.