Forex: Making Sense Of The Euro/Swiss Franc Relationship
Posted on: July 17, 2008 - 9:51am
Financeman
Posts: 79
Joined: 2008-04-30
Forex: Making Sense Of The Euro/Swiss Franc Relationship
If you're interested in getting into the forex market, there is one relationship of which you must be aware before you even start trading. This is the relationship between the euro and the Swiss franc currency pairs - a correlation too strong to be ignored. In the article Using Currency Correlations To Your Advantage, we see that the correlation between these two currency pairs can be upwards of negative 95%. This is known as an inverse relationship, which means that - generally speaking - when the EUR/USD (euro/U.S. dollar) rallies, the USD/CHF (U.S. dollar/Swiss franc) sells off the majority of the time and vice versa. When you're dealing with two separate and distinct financial instruments, a 95% correlation is as close to perfection as you can hope for. In this article we explain what causes this relationship, what it means for trading, how the correlation differs on an intraday basis and when such a strong relationship can decouple. Read on and you'll also find out why, contrary to popular belief, arbitraging the two currencies to earn the interest rate differential does not work.
Where Does This Relationship Come from?
In the article Using Currency Correlations To Your Advantage, we see that over the long term (one year) most currencies that trade against the U.S. dollar have an above 50% correlation. This is the case because the U.S. dollar is a dominant currency that is involved in 90% of all currency transactions. Furthermore, the U.S. economy is the largest in the world, which means that its health has an impact on the health of many other nations. Although the strong relationship between the EUR/USD and USD/CHF is partially due to the common dollar factor in the two currency pairs, the fact that the relationship is far stronger than that of other currency pairs stems from the close ties between the eurozone and Switzerland.
As a country surrounded by other members of the eurozone, Switzerland has very close political and economic ties with its larger neighbors. The close economic relationship began with the free trade agreement established back in 1972 and was then followed by more than 100 bilateral agreements. These agreements have allowed the free flow of Swiss citizens into the workforce of the European Union (EU) and the gradual opening of the Swiss labor market to citizens of the EU. In fact, 20% of the Swiss workforce now comes from EU member states. But the ties do not end there. Sixty percent of Swiss exports are destined for the EU, while 80% of imports come from the EU. The two economies are very intimately linked, especially since exports account for over 40% of Swiss GDP. Therefore, if the eurozone contracts, Switzerland will feel the ripple effects.
If you're interested in getting into the forex market, there is one relationship of which you must be aware before you even start trading. This is the relationship between the euro and the Swiss franc currency pairs - a correlation too strong to be ignored. In the article Using Currency Correlations To Your Advantage, we see that the correlation between these two currency pairs can be upwards of negative 95%. This is known as an inverse relationship, which means that - generally speaking - when the EUR/USD (euro/U.S. dollar) rallies, the USD/CHF (U.S. dollar/Swiss franc) sells off the majority of the time and vice versa. When you're dealing with two separate and distinct financial instruments, a 95% correlation is as close to perfection as you can hope for. In this article we explain what causes this relationship, what it means for trading, how the correlation differs on an intraday basis and when such a strong relationship can decouple. Read on and you'll also find out why, contrary to popular belief, arbitraging the two currencies to earn the interest rate differential does not work.
Where Does This Relationship Come from?
In the article Using Currency Correlations To Your Advantage, we see that over the long term (one year) most currencies that trade against the U.S. dollar have an above 50% correlation. This is the case because the U.S. dollar is a dominant currency that is involved in 90% of all currency transactions. Furthermore, the U.S. economy is the largest in the world, which means that its health has an impact on the health of many other nations. Although the strong relationship between the EUR/USD and USD/CHF is partially due to the common dollar factor in the two currency pairs, the fact that the relationship is far stronger than that of other currency pairs stems from the close ties between the eurozone and Switzerland.
As a country surrounded by other members of the eurozone, Switzerland has very close political and economic ties with its larger neighbors. The close economic relationship began with the free trade agreement established back in 1972 and was then followed by more than 100 bilateral agreements. These agreements have allowed the free flow of Swiss citizens into the workforce of the European Union (EU) and the gradual opening of the Swiss labor market to citizens of the EU. In fact, 20% of the Swiss workforce now comes from EU member states. But the ties do not end there. Sixty percent of Swiss exports are destined for the EU, while 80% of imports come from the EU. The two economies are very intimately linked, especially since exports account for over 40% of Swiss GDP. Therefore, if the eurozone contracts, Switzerland will feel the ripple effects.