What the two states look like
In risk on, money moves towards growth: equities rise, volatility drifts down, credit trades well, and the currencies of countries that export commodities do better than the ones people hide in. In risk off it reverses, usually faster than it went up, because selling is more urgent than buying.
The currency side of it is remarkably consistent. The Australian dollar, the New Zealand dollar and the Canadian dollar are the cyclical side: they are tied to commodities, to trade and to how comfortable the world feels. The Japanese yen, the Swiss franc and the US dollar are the other side.
Why those three are the havens
- The yen. Japan holds an enormous amount of money invested abroad. When the world gets nervous, some of it comes home, and the yen rises because of the flow rather than because of anything Japan did that week.
- The franc. A long record of holding its value, a current account surplus and a small, stable economy. People park money there precisely because nothing happens there.
- The dollar. The world borrows in dollars and prices oil in dollars. A scare raises the demand for the thing everyone owes, which is why the dollar can rally on bad American news.
Reading it before the currencies move
By the time a currency ranking reflects the mood, the move is under way. The markets that turn first are not currency markets at all: equity indices, the volatility index and how much it changed, credit spreads, and the commodities that track industrial demand.
That is why the risk sentiment pillar in our own scoring reads those markets rather than the currencies themselves, and why it is the heaviest of the four, worth up to 40 points of a currency score. On a strong risk-off day it can move all eight scores before a single release has been published. How the four parts fit together is on the fundamental bias page.
When the pattern lies to you
When the shock starts in a haven. A scare about Japanese policy or about American debt makes the usual safety trade the risky one.
When the carry unwinds. A crowded position in a high yielding currency can be sold in a hurry, and the funding currency it was borrowed in jumps far more than the news of that day justifies.
When it is only equities. A fall in one stock market on one company's results is not a risk-off week. If credit, volatility and commodities disagree with the equity market, the mood has not turned.
We measure this in our own backtests. Setups picked in risk-off stretches have not been the better ones: over five years of daily lists they landed below the ones picked in calmer or risk-on stretches. It is a reason to trade smaller in a panic, not a reason to fade it.
What to do with it
Two practical things. First, when the mood is strongly one way, the correlation between your positions matters more than usual: long Australian dollar and short yen in the same account is one bet, not two. Second, a bias that comes from the risk mood alone is the least durable kind, because the mood can turn in an afternoon and take every score with it.
On the days the mood does the driving, our own page says so in plain words rather than hiding it in a number, and the ranking carries the reason next to each currency. What that looks like day by day is on the track record, misses included.