Euro/Swissie: central bank action to come?

By Jaime Macrae

The Swiss franc has returned to the center stage of the forex world in recent days. Interest in the Swiss currency has revived after almost two years in relative obscurity following the Swiss National Bank’s decision to impose a cap against further appreciation versus the euro in September 2011, which effectively pegged the currency at 1.20 for most of 2012.

The Swiss franc, much like the Japanese yen, had been perceived to be a safe haven for investors during the past five years of intermittent financial crises, causing the currency to appreciate markedly since 2007, which in turn put pressure on consumer prices in Switzerland and hampered exports to its European neighbors.

The SNB successfully defended its decision to impose a ceiling on further appreciation against the euro, which is not surprising, because it has the ability to print unlimited quantities of its currency with which to buy euros. In the process, the bank has amassed huge amounts of the common European currency, more than doubling its holdings since the ceiling was imposed, and giving it the fifth largest foreign exchange reserves in the world.

While the move to stem the rise in the franc has been successful, it has not been enough to stop the persistent deflation that has plagued Switzerland, which has seen consumer prices decline for 19 consecutive months. In response, Thomas Jordan, chairman of the SNB, told reporters on May 22 that the central bank could take rates negative, effectively taxing savings to weaken the currency. He also indicated that the central bank could shift the cap on the franc lower, meaning further appreciation of the euro vs. the franc. Following his comments, the Swiss franc sank to a two-year low against the euro.

If the SNB were to pursue a policy of negative rates, whereby excess reserves deposited with the central bank would be charged interest that would then be passed along by the banks to their depositors, the appeal of holding Swiss francs would be tarnished. Alternatively, the SNB could also raise the 1.20 cap, which would be easier now that the franc has traded away from that level. In either event, the central bank has demonstrated both the ability and the will to see the franc move lower relative to the euro. Given the well-defended 1.20 cap on franc appreciation, the risk in being short the Swiss franc seems well defined.

The CME has a listed futures contract on the euro/swiss cross, which is the easiest way to express a view on the currency. The risk in this trade is a return to a highly risk-adverse environment where investors are willing to pay a high premium for the relative safety of the Alpine currency. Stops should be placed below 1.1950, at a level that would indicate the SNB had broken with its policy of containing the rise of the franc.

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