This is what happens when the BIS is limited to buying EUR and selling gold at one time: something leaks. In this case the Swiss 2 year which is plunging to -0.45% sending the curve negative to the 6 year mark, while in Germany the Bund curve is now negative to the 3 year mark. And so Europe is unfixed again - even though the SNB seems to 'love' EUR as it is entirely unable to diversify its reserves which now have surged to 60% EUR as questions over the sustainability of the peg increase.
Swiss (green) and German (blue) yield curves are negative to the 6Y and 3Y maturity respectively...
and from Citi's Steven Englander: On Swiss Reserves...
SNB having more difficulty diversifying than market anticipated
Data showing the currency composition of Swiss reserves suggest the SNB may be having more difficulty diversifying than investors were giving them credit for. The data on end Q2 holdings released today shows, the share of EUR in reserves up to 60% from 51% in Q1. In Figure 3 we show the approximate increase in reserves broken down by currency. Taking into account the overall rise in reserves and changes in valuation, this means the SNB was only able to diversify about 25% of the EUR it bought during Q2. This runs counter to the wisdom that the SNB was a very heavy diversifier, but it looks consistent with the experience of Asian reserves managers who have faced great difficulty in implementing diversification.
The currency implications are two-fold:
- There is more ‘wood to chop’ in terms of potential future diversification flows out of EUR into other currencies. This should be positive for alternative reserve currencies such as JPY and GBP, as well as other currencies which the SNB defines as CAD, AUD, SEK, DKK, SGD and KRW. The share of other currencies rose slightly in Q2. Given that these currencies declined over this period, this implies a bit (but not a lot) of active buying by the SNB. It is not clear that an immediate acceleration of SNB buying of these currencies is due in the months ahead, but even a small amount of buying can have a relatively large impact given the limited liquidity for these markets. This should likewise be positive for underlying asset markets, although the bulk of SNB holdings are concentrated in AAA government securities with lesser amounts in equities and other bonds.
- This outcome could lead investors to question the sustainability of the peg. The SNB has been unable to diversify a large portion of its euro holdings, so investors may see greater risk of severe capital losses (and potential desperation selling) down the road. Thus investors may be less inclined to believe that the SNB can maintain its present course in the face of mounting pressure. We doubt this will translate to an immediate test of the peg, but this could see increased pressure over time.