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Don’t chase EURCHF higher; custodian bank warns on franc weakness

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For the first time in five months, EURCHF has moved higher from the Swiss National Bank’s (SNB) SFr1.20 floor, but the world’s leading custodian bank warns that investors would be wise not to chase the move.

The surge in EURCHF comes amid speculation that the SNB will raise the floor in EURCHF up to SFr1.22 at its policy meeting next week. That has sparked renewed interest in the moribund currency pair, with a leading investment bank seeing four times the usual level of activity as investors rush to cut short positions. Quite where the figure of SFr1.22 comes from is something of a mystery, but it fits nicely into the story that current market conditions could afford the central bank leeway in adjusting its currency policy. Economic data from Switzerland have disappointed, most notably Tuesday’s contraction in GDP, which might have stiffened the SNB’s resolve to protect its export sector from the strength of the franc. More importantly, European Central Bank president Mario Draghi’s fulfilment on Thursday of his late July pledge to do “whatever it takes” to ensure the survival of the euro has also played its part. The central bank’s new peripheral eurozone bond buying scheme appears to have lessened haven demand for the franc. But the real move in EURCHF came on Friday after the SNB released its FX reserve data. That showed that the central bank had been less active in August – following Draghi’s pledge – in defending the floor, sending EURCHF up through SFr1.22. Figures from the SNB showed its FX reserve growth slowed to SFr9.825 in August, down from an average of SFr57 billion over the previous three months. Reserve growth, in short, fell off a cliff. Bank of New York Mellon, the world’s largest custodian bank, with $26 trillion under management, says that on the face of it the shift looks meaningful, but suspects that there is less to it than meets the eye. Simon Derrick, head of FX strategy at Bank of New York Mellon, says it was hardly surprising that reserve growth slowed in August given the rise in EURUSD over the month, which was driven by expectations that the ECB would announce a significant new support programme for the sovereign debt markets. “Indeed, it could be argued that the reserve growth seen in August was on the highish side when compared with that seen during the opening months of the year, when the EUR was benefiting both from the impact of the first LTRO and in anticipation of the impact of the second,” he says. The reserve figures were consistent with the picture painted by Bank of New York Mellon’s iFlow data, which track the changing positions of investment managers and asset managers held in custody by the bank. 

CHF cumulative flow versus USDCHF

 Source: BNY Mellon iFlow
The iFlow data monitored heavy inflows into the CHF from May 9 onwards as the Greek crisis started to intensify. Around July 24, the time when Draghi first hinted that he was prepared to take fresh action to stabilize eurozone sovereign debt markets, there was a turnaround in those flows that lasted until August 9 when the focus began to shift back to concerns over Greece as well as German opposition to the ECB’s proposed bond-buying programme. Fresh inflows re-emerged around then and continued on until the end of the month when anticipation once again began to build as to what the ECB might do. “We strongly suspect it indicates that there has been no meaningful shift in the underlying forces driving the CHF – and SNB reserve growth,” says Derrick. “Increases in pessimism about the outlook for the eurozone continue to spark fresh inflows into the CHF while any easing in tensions sees mild outflows occurring.” He suspects that worries over Greece will become an increasing issue through the remainder of the year. “In other words we don’t think the era of Swiss reserve growth is over just yet,” says Derrick.