The analysis team at Goldman Sachs explains that using the VIX to measure risk sentiment allows them to track how currencies behave in broad ‘risk-on’ or ‘risk-off’ periods – recently the yen has generally appreciated in ‘risk-off’ periods with a rising VIX, while the euro has weakened.
“While the VIX is based on equity volatility, it tends to reﬂect broad ‘risk on, risk off’ across assets. In fact, we ﬁnd the same relationships with our cross-asset Risk Appetite Indicator (RAI) - a decline in risk appetite tends to support the yen and has recently weighed on the euro. While the ‘risk off’ nature of the yen has weakened since the peak at the end of 2015, it still stands out as the key ‘risk off’ currency, both based on the positive correlation with the VIX and the negative correlation with our RAI. Even gold, which is somewhat similar to a currency, has beneﬁted less from a ‘risk off’ move recently. The Swiss franc has become less ‘risk off’ in recent years.”
“The euro in contrast has switched between ‘risk on’ and ‘risk off’ since the GFC, driven by political risks. For example, during the euro area crisis in 2011/12, European equities were strongly positively correlated with the euro. This is because the euro reﬂected euro area political risks and the potential for a break-up of the EMU. This same has been true again more recently with European political risks picking around the UK referendum and the French elections. As a result, the GBP has also been the most ‘risk on’ currency globally in the past year.”