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Foreign Exchange

Traders on alert for CHF intervention

The recent appreciation of the Swiss franc has raised the probability that the Swiss National Bank will intervene to weaken the currency, with many looking to take advantage through the options market.

The Swiss franc has risen to its highest level against the euro since September, when the SNB introduced a SFr1.20 floor in EURCHF in an attempt to counter what it described as the “massive overvaluation” of the currency. The aggressive stance of the SNB, which promised to defend the floor with “utmost determination” and said it was prepared to buy foreign currency in “unlimited quantities”, has seen the SFr1.20 floor hold. Since the resignation of Philipp Hildebrand as chairman of the SNB earlier this month, however, the franc has climbed steadily higher.

Some put the strength of the franc down to speculation that without Hildebrand, who was forced to quit after revelations over his wife’s FX dealing, the SNB’s resolve in fighting the currency’s strength has diminished.

This, however, was not the message from Jean-Pierre Danthine, SNB governing board member, last week.

 SNB's Danthine: strong resolve

Saying that he deeply regretted Hildebrand’s departure on a personal level, Danthine stressed that the SNB’s policy stance was the result of teamwork, and that its resolve to enforce the currency floor remained as strong as ever.

Chris Turner, head of foreign exchange strategy at ING, says the SNB has too much political capital invested in the floor to adjust it or let it break.

“We very much doubt that he SNB governing council will swerve from the mission to protect the floor with utmost determination and unlimited FX intervention,” he says.

Turner believes the weakening trend in EURCHF is more likely the result of the massive euro liquidity injections from the European Central Bank through its LTRO, which have offset the flood of Swiss franc liquidity that was unleashed by the SNB last Autumn.

As a pre-cursor to the introduction of the floor in September, the SNB aggressively added liquidity in August as a means to drive down market interest rates, even sending short-dated franc Libor negative. That was achieved by increasing franc sight deposits – bank holdings at the SNB – from SFr30 billion to SFr250 billion.

 EURCHF versus CHF sight deposits

 Source: SNB

Turner says as a means of unleashing another round of intervention, the SNB could move to inject more liquidity, for example by setting a SFr400 billion target for sight deposits.

“With traded volatility now low, more aggressive accounts could look to position long EURCHF through the options market, where a SFr1.21 one-month EUR call/CHF put currently costs 0.5%,” he adds.

Mansoor Mohi-Uddin, head of FX strategy at UBS, also recommends betting on weakness in the franc through the options market.

He expects the SNB to remain committed to the floor in order to protect its exporters, especially given the fact that Switzerland’s widely-watched Kof leading indicator fell to -0.17 in January, its first negative reading since August 2009.

Mohi-uddin agrees with the SNB’s stance that the franc will depreciate “in the future” given the currency is too strong for the economy to avoid deflation, and belives the central bank will eventually raise the floor in EURCHF.

“But in the near term it's clear the market is worried about a test of the EURCHF 'floor' in the wake of SNB President Hildebrand's resignation,” he says.

“As a result we think EURCHF bulls should not have spot positions but instead buy long dated out of the money call options with strikes at 1.30 for an eventual move of the floor higher.”

Olivier Korber, strategist at Societe Generale, notes that EURCHF has traded in a very tight range since the SNB set the SFr1.20 floor in September, with realised volatility falling close to zero at the end of December and hardly increasing since then.

He says with spot still close to Fr1.20 in EURCHF, any volatility increase should only happen on the topside. However, risk reversals are pricing euro puts over calls for the entire curve, except the very front end.

“That is a screaming anomaly in our view,” says Korber. “For investors who are confident that the SNB’s willingness to see a weaker franc is set to materialise, selling risk reversals is an attractive proposition.”

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