Non-parallel universes

The expected interest-rate differential between two currencies is an excellent starting point for examining a currency cross-rate. The key metric for a currency is the forward rate ratio (FRR) between six and nine months, which is the rate at which we can lock in borrowing for three months beginning six months from now.

The FRR today provides a tradable interest- rate expectation applicable to the decision whether to roll a three-month nondeliverable forward for another three months starting three months from now. The more an FRR exceeds 1.00, the steeper the yield curve is over that segment and, by extension, the looser that country’s monetary policy is.

While the Swiss long have enjoyed a reputation for fiscal probity, they have been as willing as anyone to engage in monetary stimulus in recent years. Comparing the FRRs for the euro (EUR), British pound (GBP), and Swiss franc (CHF) since the January 1999 advent of the euro reveals the Bank of England (BOE) and the European Central Bank (ECB) have kept their monetary policies tightly aligned. The most notable exception was in late 2005 and early 2006 when the ECB maintained a looser monetary policy than the BOE.

Not so for the Swiss National Bank (SNB). The reduction of their target LIBOR from 0.75 to 0.25 percent in March 2003 — three months before the Federal Reserve cut the federal funds rate to 1 percent — propelled their FRR higher and well over comparable levels in the UK and Eurozone. Their increase of the target LIBOR in June 2004 to 50 basis points matched the Federal Reserve’s move in timing and size, and it started a very rapid change in their FRR.