Euro Weakness Dragging Down Krona and Swiss Franc ETF

by on May 26, 2010 | ETFs Mentioned:

Highlighting the extent to which global markets are now interconnected, fiscal weakness in continental Europe has dragged down equity markets around the world in recent weeks. Among the hardest hit countries over the past month was Spain; the iShares MSCI Spain Index Fund (EWP) has sunk by about 20% over that period. However, the contagion has greatly impacted more developed and prosperous nations as well. The more fiscally sound country of Germany saw shares tumble as well; the iShares MSCI Germany Index Fund (EWG) plummet by about 17% in the same period. Falling values in local markets have been exacerbated by a weak euro zone currency, which has seen its value drop tremendously against the dollar as of late. The most popular euro ETF, CurrencyShares Euro Trust (FXE) is off by more than 7.7% over the past month and 14% thus far in 2010 (see Three ETF Plays For Euro/Dollar Parity).

Despite remaining outside of the euro, the Swedish krona and the Swiss franc have suffered collateral damage from the euro collapse. The CurrencyShares Swedish Krona Trust (FXS) is down 10.3% over the past month, while the CurrencyShares Swiss Franc Trust (FXF) is down 7.3% over the past month and 10.7% thus far in 2010. These steep drops have occurred for several reasons. In regards to the Swiss franc, there is a history of currency interventions by the Swiss Central Bank in order to keep the currency at tolerable levels against the euro, including three major interventions in the last six months. While in the short-term these actions may have the desired effect against the euro, such interventions also weaken the currency against the U.S. dollar (the exchange rate the CurrencyShares funds are designed to track). Thus, Swiss Bank interventions have helped to keep the lid on the franc against the euro, but in doing that they have helped to send the franc sharply lower against the greenback, which has had a negative impact on FXF (see technical analysis of FXF here).

Sweden, on the other hand, is not known for government intervention. While its currency, the krona, has experienced weakness as of late, equity markets have been doing quite well in comparison to its European counterparts (see Inside The Europe ETF That Hasn’t Plummeted). This makes currency intervention even less likely, since many Swedish companies have yet to feel the pinch from a currency that is sharply stronger against the euro. Furthermore, Sweden is seen as one of a few European countries likely to raise rates in the near future. “However, the fear of rapid currency climbs could hold Nordic central banks back from rises in interest rates,” said Emma Lawson in an interview with the Wall Street Journal. “In addition, the heavy weight of bets in favor of these currencies means that sharp turnarounds are a threat.” This fear may help to keep rates in Sweden lower than normal and it could be a catalyst for the current weakness in FXS (see fundamentals of FXS).

Recent history has shown us that world economies are more intertwined than ever before, and those ties are particularly strong in Europe. Despite having differing economic conditions and rates, both of these non-euro European currencies have a strong correlation with FXE over the past six months. This suggests that although Sweden’s equity markets have outperformed the rest of Europe, its krona has not been immune to the downswing and has fallen almost as hard against the dollar as the euro has. It appears that as the main powers of Europe go, so goes the rest of Europe, no matter how fiscally sound or responsible they may be (see Why The European Bailout Is Just Postponing The Inevitable).

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Disclosure: No positions at time of writing.