Swiss Franc: Caught Short On Long? Blame the Treasury

The swissy made dramatic moves in trade on Wednesday, moves that were instigated by the upcoming U.S. government sale of $17 billion dollars of 10 year note debt. An increase in the number of notes in the market decreases the existing note's value and automatically increases the yield paid. The 10 year note moved from paying 3.95% yesterday to 4.05% today, and in turn sent the swissy on a parabolic move to touch 1.0600 in U.S. trade. These moves were initially negated by the news that the government backed entity, Freddie Mac, were reporting losses of $821 million this quarter, but soon found momentum once Wall Street got to work.

Trading The Trend. On days that the 10 year Treasury yield and the US dollar index are in alignment traders know that the moves made by the Usd are more likely to hold than those made on days that they are out of line. As Trade Desks move from equities they tend to move to treasuries and bonds, and in doing so decrease the yields paid. Note value increases equate to yield decreases. The converse reaction comes from positive equity days; higher stocks equate in general to lower bonds, and higher treasury yields.

A decreasing yield tends to drop the value of Usd/Chf, and vice versa. A trending 10 year treasury yield will invariably drag the Usd with it, and will be seen primarily in the swissy (Usd/Chf). Checking that the Usd/Chf is moving in the direction of your dollar based trade offers more confirmation of market sentiment towards the dollar. Neither of these are 'deal breakers', but trades taken on days that the Dollar Index/Treasury link is in place tend to be less volatile.

Promissory Note. The U.S. treasury note is nothing more than a Promissory Note issued by the US Government that says over a certain time they will honor both the note and the interest rate that it bears. It is used by the Fed to cover borrowing requirements to fund Government spending. U.S. treasuries are deemed to be the most secure of any global treasury note, and are the most liquid of all traded T-Bills globally. The question of how long overseas investors will continue to buy U.S. debt is asked more often now that the U.S. budget deficit and current account overdraft have increased, but in reality the option not to sustain the dollar, and therefore reduce the value of the debt already held, is a moot point. Most sovereign wealth funds are so deep in U.S. debt that they have to support dollar values to maintain their reserve/asset ratios, and to stabilize their own currency. Like it or not, toxic or clean, the world buys U.S. debt because there is very little choice. It is not desire in most cases, it is necessity. 

Currency impact. The Interest Rate is an integral mechanism of currency flow throughout the world. Corporations, governments, and individual investors always seek to increase Reward while decreasing Risk, and U.S. treasuries are considered 'risk free' investments.  Therefore when the yield differential between U.S. treasuries (in this case the 10-year note) increases when compared to other countries, the U.S. Dollar tends to gain (higher return for less risk). As the yield on the note increases the intrinsic value of the note reduces and vice versa; there are Treasury Notes 'values', and Treasury Note 'yields', they move in opposite directions. The appeal of U.S. treasuries is also derived from its attractiveness as a safety net, or as a "flight to quality" instrument. In uncertain times purchases of these instruments increase, as an insurance against a worst case scenario. When international institutions buy U.S. Treasuries they exchange their local currency to dollars, and then complete the treasury purchase in $ denominated accounts.

In general: Yields Up = US$ Up    Yields Down = US$ Down

Economic Impact. The 10-year Treasury note has the greatest impact on the U.S. economy due to its influence on long term interest rates. While the Federal Reserve controls the overnight rate, interest rates paid on long term financing for capital goods, as well as the housing market, are established by asserting a premium over the 10-year treasury note. In other words whatever the 10 Year note is worth determines the rates for mortgages, investments and loans that are set from that starting point.

Central Bank Reserves. Central Banks maintain a large percentage of their foreign Dollar reserves in 10-year notes due to its time to maturity, as well as its liquidity. 30-year notes are only issued by the Federal Reserve in times of significant budget deficits, and therefore the 30 year is a secondary market, demand for such securities is small due to its limited issuing. Yields on 30 year bonds touched their highest rate in two weeks today as the market prepared for the sale of $10 billion of new notes on Thursday, the largest amount of 30 year debt offered in over two years.

Disclosure: No stock positions

Comments

[TinyTim:]

sh*t, now you tell me

2008 Aug 07 10:48 AM