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One of my Treasury market colleagues brought up an interesting subject today by way of asking me how many euros the Swiss National Bank (SNB) owns as a result of its intervention to prevent the franc from being too overvalued against the Eurozone currency (which I’ve discussed before). The discussion point he was working toward was that the SNB likely has been a major buyer of German government debt as a result of its euro purchases. That and the flow of capital out of the EZ periphery (Greece, Spain, Portugal, etc.) in to German paper has served to depress yields there.

Consider this. The ECB has set the overnight rate for the euro at 1%, yet the German 2yr yield is currently running at about 0.14%. Compare that to the US were the Fed has set overnight rates at basically 0% and 2yr yields are currently about 0.27%. This negative yield spread (-13 basis points currently) is part of what’s been keeping EUR/USD under pressure.

The chart below shows the relationship between the 2yr Germany-US yield spread and the EUR/USD rate. The upper plot is EUR/USD. The middle plot is the yield differential. The lower plot is the rolling 20-day correlation between the two. Notice how that correlation has been positive the vast majority of the time.

The big question out there among many market participants is why the euro isn’t weaker given all the problems in Europe at the moment. We can look at the low rates in the US and Germany as part of the equation. It’s hard for the yield spread to go too much lower from here so long as US rates aren’t on the rise and Bernanke (and the last US jobs report) has done a pretty good job of keeping them down. If the positive correlation holds, it will likely take improved US economic expectations driving US yields higher to really help push EUR/USD down.

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Author Bio

Today is one of those days in the forex market that definitely do not come along very often. The announcement from the Swiss National Bank (SNB) that they will be enforcing a minimum EUR/CHF rate of 1.20 saw the cross jump nearly 10% in very short order. That’s one of the biggest daily exchange rate moves there’s ever been among the major currencies, and no doubt caught a lot of folks positioned the wrong way.

Now, it should be noted this isn’t a “peg”, as it has been called in the press. A better term would be “enforced floor”. The SNB has not officially set EUR/CHF at 1.20. It has simply said that any rate below there is unacceptable and it will sell as many francs as necessary to keep that from happening. From the press release:

“With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.”

They are happy, though, for EUR/CHF to move above 1.20.

Note that this does not mean USD/CHF cannot move down, or that the other CHF cross rates can’t reflect better Swiss strength. Those movements would happen as a function of the EUR strengthening against the other currencies, however. For example, USD/CHF would fall with EUR/USD rising. Since the Euro Zone is the main trade partner for Switzerland, though, the SNB isn’t really worried so much about non-EUR exchange rates.

The interesting factor in all this is what happens on the Swiss inflation front. The SNB has basically just committed to flooding the world with francs if required. That seriously dents the CHF safe-haven status, and probably puts gold more in the spotlight in that regard. It also means, though, that import prices are likely to face upside pressure. If that forces the SNB to raise rates, this could actually work against the forex intervention by making the CHF more attractive.

More immediately, though, I can’t help but wonder how long it will be before the markets test the SNB’s resolve. There’s nothing to prevent those who want CHF from buying it via non-EUR pairs. If that then forces the SNB to buy EUR/CHF, things could get very interesting, as a strengthening euro isn’t likely to be seen all that positively by some in the Euro Zone.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.