Fundamental Evaluation Series: USD/CHF vs. 2-year 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 as it benefits 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 negative 16 percent, though, at times, it has shown relatively high positive correlation, as high as 90 percent. 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, until recently.
• 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.
• In our last review in August, we noted that there have been minor changes in the spread compared to the July review which was trading at 213 basis points in favour of the dollar. The spread had narrowed by 4 basis points in favour of the Swiss franc since July review and the franc strengthened by 30 pips and trading at 0.965 per dollar. The 20-day correlation between the exchange rate and yield spread has recovered from negative to positive.

Since our last review in August, we can see that the spread has widened in favour of the dollar by 12 basis points and the franc has weakened against the dollar by 40 pips. There is still quite a gap between the exchange rate and the yield spread. The spread is currently at 225 basis points and the USD/CHF is at 0.968. The positive 20-day correlation has turned more positive and is currently at 23 percent from 2 percent in the last review, which shows that the focus is once again turning to yields.

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