Swiss National Bank notches up a victory, but Swiss currency war continues

By:
Peter Garnham
Published on:

It might be too early for the Swiss National Bank (SNB) to declare victory in its currency war, but it has at last won a battle in its campaign to weaken the franc.

EURCHF has risen above SFr1.2250 to its strongest level in more than a year, while three-month volatility in the currency pair has risen to its highest level since September.

Meanwhile, risk reversals, which measure the demand for EURCHF calls over EURCHF puts, have not been as skewed in favour of continued strength in the single currency against the franc for 10 years.

Many now see the potential for a sharp rally in EURCHF, with an initial jump up to SFr1.25 within easy reach, as franc weakness catches up with declines in other haven currencies.

EURCHF has remained tied to the SFr1.20 floor the SNB imposed in September 2011 since its inception. Brief rallies in the currency pair have been triggered by speculation that the central bank was to raise the floor to protect its export sector from the remorseless strength of the franc.

However, this move is different.

Instead of speculation that the SNB is set to impose a new, higher floor in EURCHF, franc weakness has been accompanied by talk that the central bank has been in the market buying EURGBP and EURJPY, reversing the diversification flows that bolstered the UK and Japanese currencies last year as the SNB tried to spread the currency risk within its burgeoning foreign exchange reserves.

Those FX reserves have reached record levels as worries over the eurozone debt crisis sparked massive haven demand for the franc. The SNB’s stockpiles now stand at more than SFr400 billion, or nearly 70% of Swiss GDP, and the central bank has warned that managing those reserves is a substantial challenge.

 

 

Respite 

Now, though, there appears to be some respite for the SNB, as the franc has finally succumbed to the selling pressure that has dented demand for the world’s other favourite haven currencies – USD and JPY – as the new year has heralded a renewed surge in investor confidence.

Crucial to the ability of the CHF to play catch-up with the weakness in the USD and the JPY has been increased optimism surrounding the eurozone. That followed the declaration last week from Mario Draghi, European Central Bank president, that the region’s financial crisis – if not economic crisis – is as good as over.

Indeed, as Kit Juckes, head of FX strategy at Société Générale, puts it: “The SNB has won its battle, for now, which tells us more about capitulation of EUR bears than capitulation of CHF bulls, I suspect.”

Still, the capitulation of EUR bears on declining systemic risks within the eurozone – Spanish bond yields, for example, are down below 5% for the first time since March – means the need for holding a haven currency such as the CHF has declined markedly.

More importantly, the recent decline in the JPY implies there is plenty of room for a sharp sell-off in the CHF. The JPY has fallen nearly 20% against the EUR since hitting a high in November, while until last week CHF barely moved.

That implies the market is still long of CHF, while JPY positions have already been reversed on improved risk appetite and bullish EUR sentiment.

Audrey Childe-Freeman, head of FX strategy at BMO Capital Markets, says with some EUR crosses, and EURJPY in particular, appearing overstretched, investors should start to look at alternative trades to play a more bullish EUR view.

“EURCHF has to be a winner in this context,” she says.

BMO has a medium-term target of SFr1.25 for EURCHF, and it is not alone in believing that the currency pair can quickly move to that level as short-term positions are liquidated in the face of improved sentiment towards the EUR.

As ever, the longer term is trickier to predict. A continuation of CHF weakness will depend on a continued decline in risk aversion and investors maintaining the belief that the worst of the eurozone crisis is behind them.

So while a EURCHF move to SFr1.25 in short order might look imminent, the chances of a sustained, longer-term rally that takes EURCHF above SFr1.30 and back towards the SNB’s comfort zone are more debatable.

The SNB can afford to relax for now, but its war against currency strength is far from over.