Morning Commentary: Real Differences

Foreign Exchange - Morning Commentary
Real Differences 
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The Swiss franc continues to defy gravity despite an improving market backdrop that includes declining financial stress and improved liquidity conditions.  

Time zone analysis shows USDCHF has been aggressively sold during the US market session since mid-July.  This dynamic combined with market positioning goes some ways towards explaining the CHF’s recent performance.  However, the resilience that CHF has shown to the broader improvement in market conditions and global data goes beyond these factors alone.  Looking at market data, this explanation gap is filled by the move in real yields and the pace of balance sheet expansion in the G10.  

The evolution in real yields between the USD and other G10 currencies has been dramatic with the drop in real yields a key driver of USD underperformance.  On a YTD basis, the USD real yields have dropped the most in the G10 (by a significant margin) while CHF real yield improvement sits near the top of the G10.  On an absolute basis, US real yields are at their most negative level since 2014 when the Swiss franc was more than 3% stronger than its current level.  Additionally, the possibility of the Fed implementing stronger forward guidance and potentially yield curve control would further compress US real rates.    

Regarding balance sheet expansion, the Swiss National Bank’s (SNB) intervention program has garnered a lot of attention.  Despite the SNB’s FX intervention, the CHF’s balance sheet expansion pales in comparison with the balance sheet expansion seen in Canada, New Zealand and the US.  With both the ECB and the Fed seeing their balance sheet rise due to their QE programs, the gap between the SNB’s balance sheet growth and the rest of G10 should continue to persist.    

The CHF benefits from a rock solid balance of payments surplus and better internal debt dynamics versus its G10 peers.  This supports further CHF strength especially if there is a continued compression of global yields.
  • US initial jobless claims missed estimates by coming in at 1.1 million versus consensus for a 920K print.  Additionally, last week’s number was revised up slightly to 971K from 963K.  This disappointing result adds another point supporting the narrative that labor market momentum may be waning.  On a positive note, continuing claims dropped to 14.8 million from 15.5 million and beat estimates.   
  • US-China relations are evolving at a very fast pace.  Just a day after President Trump said he cancelled the call, China announced that the two countries will in fact hold a call to review progress on their Phase 1 deal.  Meanwhile, the US has suspended its extradition and tax treaties with Hong Kong.  
  • President Trump has called on the UN to reinstate all nuclear-related sanctions against Iran.  However, key allies such as the UK and France have questioned whether the US has the authority to do so.  
  • The Federal Reserve minutes were released yesterday and hit market risk sentiment, driving equities down and the USD higher.  Market participants that were hoping for details on the policy review were disappointed as nothing was provided other than indications that it would end soon.  On policy, the Fed appeared to step back from previous language on stronger forward guidance, remained noncommittal on yield curve control and did not discuss negative rates.
  • US stimulus talks remain “rather stalled” in the words of Larry Kudlow.  The White House indicated that it would be willing to increase Postal Service aid but would require compromise on stimulus checks and small business aid.
  • Germany is likely to extend its job furlough program to 24 months.  Currently, it is limited to 12 months.  It is also possible that the UK will extend its jobs program too.  Currently, the UK’s furlough scheme is set to expire in October.  While Chancellor Sunak has stated that it won’t be extended, continued weakness in the labor markets could provide the needed pressure to do so.  
  • Spain continues to be at the center of Europe’s virus surge after recording its highest daily increase since April.  Germany and France are also seeing large upticks in infections.  
  • Norway’s central bank left rates unchanged as expected and kept its forward guidance unchanged from June.
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