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Credit Doesn't Care About EURCHF

An Interesting Swiss Divergence

Last week Switzerland gave us all a move that we will be talking about to our grandchildren. After undertaking an incredible exercise in balance sheet expansion, the Swiss National Bank gave up its EUR peg. In one day you saw an epic move in CHFEUR from 0.8314 to 1.0071: it’s a big deal.

My uncle Larry would have had a good chuckle. Not to trivialize the move, but because it is just another proof of the grand absurdity of trying to time, predict, and otherwise read the bones on the future. The best you can do is figure the downside and upside of a trade based on current information and have a clear, healthy respect for the fact that probability serves merely as an imperfect, degree-of-belief kind of measure.

The impact in FX was devastating for a lot of brokers on a global scale and it spells serious trouble for Swiss economic competitiveness. Frankly, broader credit indices didn’t care much. Switzerland is a AAA credit and as such it is a little silly to buy CDS on it. Various European (non-Swiss) households pay CHF denominated mortgages, which caused Hungarian and Polish CDS to widen. But from a global credit perspective, this was not epic.

What this de-peg signaled is that the Swiss aren’t going to be dragged into effectively hyper-QE just to keep up with the ECB’s bond buying. And this just strengthens an interesting credit divergence shaping up. Check it out:

interesting divergence.jpg

In fact, the explanation for this divergence between European, NA, and Japanese IG is multi-layered. Bund yields and other reference debt in Europe are at historic lows, and this in turn drives European high grade cash bond yields down based on spread compression. The implicit arbitrage between cash and synthetic is pulling iTraxx Europe tighter.

This spread compression driver is overlaid on a European market already pricing in a deeper economic slowdown than is currently the case in Japanese and North American credit. “Slowdown” in this context is reflected not only in poor growth but also deepening disinflation.

But there is something else: the ECB is clearly the price-insensitive buyer to front-run and this is perfect—perhaps the only feasible time—for the SNB to off-load the EUR assets they bought to support the peg. This completely unexpected move sure looks like a confirmation of Draghi’s green light to engage in a proper-size QE.

I could be wrong, of course. But I hold a firm belief that the world really is not an absurd blend of people doing inconsistent things. The Fed is tightening. Asia is in for a big slowdown given the debt bubble China will have to work through over the next few years. So it looks like traders are positioning for a melt-up in Europe by buying high-grade corporate debt. The pragmatic Swiss are, for whatever reason, de-risking.

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