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Foreign Exchange

Capital controls might be SNB’s only option; rampant demand for Swiss franc continues

No wonder Thomas Jordan, Swiss National Bank (SNB) chairman, reminded the market that the central bank has other weapons up its sleeve to weaken the Swiss franc – because investors still cannot get enough of it.

Jordan warned at the weekend that the central bank might consider capital controls to prevent haven demand pushing the currency up towards record levels should the eurozone crisis escalate. Although admittedly he did not consult EuromoneyFXNews, that was a move recommended by us early last month, when the market made the first serious test of the SFr1.20 EURCHF floor since it was imposed by the central bank in September.

Indeed, the sheer scale of demand for the franc might well leave capital controls as the SNB’s only option.

That is the conclusion from UBS flow data, which showed the week before last that hedge fund sales of EURCHF were the third largest on record.

That voracious demand has continued, according to the figures UBS released for last week, which showed the franc remains the top-performing currency in the G10.

 G10 weighted flow momentum

 
 Source: UBS

The data show that EURCHF registered the third-largest selling week this year and this time every single client category participated.

Asset managers were the dominant players, according to UBS, but private clients also picked up their selling interest, almost matching the previous week’s net selling, which was the heaviest in almost a year.

Geoffrey Yu, FX strategist at UBS, says it would appear that Jordan’s concerns are fully justified, given the flow patterns of the past two weeks.

“The SNB is not getting any help on the USDCHF leg either, as, again, every single client class was on the offer, though corporates were more aggressive with this pair,” he says.

Those flows are just a fraction of what could be headed Switzerland’s way if a country such as Greece leaves the eurozone.

Citi estimates that in the event of a Grexit, it can expect the value of its new currency to fall more than 50%.

As Valentin Marinov, strategist at Citi, notes, penalty rates on franc deposits held by non-residents could fail as an option to maintain the floor, since finding a level high enough to match the expected extreme depreciation of new national currencies could be hard.

He admits that it is difficult to quantify the total amount of inflows into the franc if the eurozone crisis escalates, but suspects their size could run into “hundreds of billions”.

“An alternative to capital controls to defend the EURCHF peg may be difficult to find in the event of a Grexit,” says Marinov.

He believes the SNB has the resolve to defend the peg and will continue to absorb any demand for francs for now.

“Absent timely capital controls, however, we doubt that any further FX market interventions or, indeed, alternative measures will allay fears that the SNB would be forced to abandon the peg,” adds Marinov.

“As a result market downside bets in EURCHF could intensify from here.”

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