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Flight to quality

The movement of capital out of risky assets into the safest available ones during stress, which in currencies means bidding up the dollar, yen and franc and selling high-yielders.

The pattern is recognisable: government bonds rally, equities fall, credit spreads widen, and a safe-haven-currency outperforms while an emerging-market-currency and the commodity bloc underperform. Correlations that looked diversifying in calm markets converge toward one.

Two distinct things are usually happening at once. Some investors are genuinely reallocating to safety; others are simply unwinding leverage, which mechanically buys back whatever they borrowed. The second effect is faster and explains the violence of the first few hours.

Liquidity conditions amplify it. A flight to quality that begins in the asian-session or over a holiday runs into thin books and produces gaps, as covered in holiday-liquidity.

Example: over three sessions USD/JPY falls 3.5%, AUD/JPY falls 6%, and an emerging market pair falls 9% with its spread tripling. Nothing changed in any of those economies.

Related: safe-haven-currency, carry-unwind, risk-on-risk-off, holiday-liquidity

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

Bid-ask spread in an order bookSell orders stacked above buy orders with a gap between the best of each.SELLERS (asks)50.0690050.051,40050.0460050.011,10050.002,30049.99800spread = 0.03BUYERS (bids)
The bid-ask spread. Buy orders sit below, sell orders above, and the gap between the best bid (50.01) and best ask (50.04) is the spread you pay to cross. Bar length shows the size resting at each price.

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