Monday, October 06, 2008

Yen vs. Swiss Franc

In the comment thread in the recent post on the U.S. dollar rally, one reader asked why the Swiss franc has performed so much worse than the yen. The yen and the Swiss franc are both traditional "funding currencies" in carry trades, and both usually rise when there is financial distress. This has certainly been true for the yen most recently, which has risen against almost all other currencies (even the USD), but not true for the Swiss franc which has fallen recently against many currencies, including the yen and the USD.

Currency movements often happen without any shift in fundamentals, so there might any explanation in that sense (although there are always some form of cash flow explanation), but in this case there are actually two good reasons why the Swiss franc has performed worse than the yen.

One is that Swiss banks have made a lot larger losses on the American mortgage market than Japanese banks. In the last few quarters, we have seen a significant decline in Switzerland's large current account surplus, despite a rising trade surplus. The reason is that the previously very large investment income surplus has been wiped out, which the statistics authorities point out is due to "turmoil in the financial markets resulted in losses in the bank's foreign subsidiaries". The decline is in the order of CHF 13 billion in just one quarter, which is equivalent to 10% of GDP.

The other reason is that the Swiss franc has been dragged down by the decline in the euro. As Switzerland is completely surrounded by the euro area (except for Liechtenstein, but that country is so small that it really doesn't count), most of its trade is with these countries, and so its currency is affected by the movements of the euro. By contrast, Japan has a far smaller dependence of the euro area as foreign trade is a much smaller part of its economy and as most of its trade is with other parts of the world, primarily the rest of Asia and the U.S.


Blogger Flavian said...

According to the theory of purchasing power parity the yen ought to rise against the swiss franc, since the swiss franc is overvalued against nearly all currencies and the yen is undervalued against most major currencies.

10:19 AM  
Anonymous ismailov said...

Don't forget the fundamentals - swissie is the only G10 currency that is backed up by both fiscal and current account surplus.

4:41 PM  
Anonymous Stuart said...

re: fiscal and CA surplus, so is the Cdn dollar.

5:48 PM  
Anonymous Anonymous said...

Talking about currencies Stefan:

Ought not the undervalued Swedush Krona rise against the overvalued Euro?

Best Regards,

7:26 PM  
Anonymous ismailov said...

stuart - Canadian CA and fiscal accounts are more like flat.

11:23 PM  
Anonymous holgs said...


One other reason, I think, is that Japan has already been through 15+ years of deflation (plus the carry trade) so they are waaay ahead of everyone else in terms of downturn.

Re: CDN $$$.. Oil crashing now and Canada's own FNM, CMHC, guarantees all mortgages themselves (instead of selling them) which means that all CDN taxpayers are on the hook for every dollar drop in housing in Canada, which has only now started to hit. (as opposed to the US where those guarantees have only now been partially added to the balance sheets of the GSE's)

12:05 AM  
Blogger stefankarlsson said...

Göran, I agree with you that the Swedish krona is undervalued relative to the euro. And so it ought to rise in a normative sense.

Relating to the point discussed by Ismailov and Stuart, Sweden has a large current account surplus and until now a large budget surplus.

However, it could take a while before that increase happens. Global markets aren't always fully rational and in times like these, smaller currencies are sold despite being in the case of the Swedish krona undervalued. This means in turn that the Swedish krona will likely remain undervalued as long as the financial turmoil continues, which it likely will for a while.

7:37 AM  

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