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Fundamental Evaluation Series: USD/CHF vs. yield divergence

During our evaluation period beginning 2012, the yield spread between the US 2-year bond and a Swiss equivalent has widened by almost 200 basis points but the exchange rate hasn’t followed through as much as it should have been benefiting from risk aversion inflows.  Swiss franc remains the most overvalued currency against the dollar, in terms of yield divergence. In recent days, Swiss franc’s correlation with the 2-year yield spread (US-Swiss 2 year) has fallen to 79 percent and time on time again it shows relatively high positive correlation, as high as 90 percent at times. Just before and after the Brexit referendum in the UK, the 20-day rolling correlation was averaging above 60. Hence, it is vital to keep a watch on the Swiss yields.

Just after the Swiss floor shock in January 2015 when the Swiss National Bank (SNB) removed a floor in EUR/CHF at 1.20 this relation went to negative and stayed there until October with an occasional bounce to positive territory. It hasn’t gone much to the negative since.

Unlike the euro or the pound, the Swiss franc is considered a safe haven currency; hence the yield relation sometimes gets overlooked.

However, Swiss yields are a must watch as they are the lowest for any government bonds in the world and any shift in that will mark a major turnaround in trend. And indeed, it has been showing a change in trend in recent days as the inflation is one the rise all around the world. Since our last evaluation in December last year, the yield spread has actually shrunken by 13 basis points. The yield spread is currently at 214 basis points in favor of treasury and the USD/CHF is trading at 1.006.

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