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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