From the January 01, 2012 issue of Futures Magazine • Subscribe!

Exploiting the franc peg

We already are seeing some market parallels with the early signs of the great financial crisis of 2007-08: Peaking global inflation rates, topping formations in G10/emerging market equities and tightening bank liquidity. As European banks rush to raise funds and borrow U.S. dollars, their borrowing cost on USD funding has risen to its highest since 2008. But one thing is different — the Swiss franc.

The Swiss currency is no longer rallying the way it did during market distress on Eurozone debt concerns. It all changed when the Swiss National Bank (SNB) announcement pegging its currency against the euro at the EUR/CHF rate of 1.20, aimed at preventing excessive franc acceleration against the debt-ridden euro. As credit rating agencies rushed to downgrade the sovereign debt of Southern Europe in late 2009, investors rushed their savings out of the single currency and into safe-haven francs. The exodus took the form of cash flight, property sales and bank transfers as "default" became a recurring theme in Greece, Spain, Portugal Greece, Ireland and Italy.

Consequently, the franc soared 35% and 40% against the euro and the USD respectively from 2009 to September 2011.

The SNB began massive interventions in March 2009 to sell its currency for euros to stem the tide of the soaring franc. But the surge of franc-bound capital caused the SNB to lose more than CHF 20 billion from early 2009 to end of 2010. When the central bank’s losses became a matter of national urgency, it ultimately went with the "nuclear option."

On Sept. 6, 2011 the SNB announced it "will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities."

SNB had pegged its currency once before against the Deutsche mark in 1978 after francs soared close to 100%, near doubling in the prior six years as a result of U.S. stagflation following the oil crisis. The franc/mark peg lasted two years and dragged down the franc’s effective trade index by about 14%.

The question then becomes whether the SNB remains successful in stemming further CHF strength. Will it make sense to sell the franc into 2012? As of this writing, the Swiss franc lost nearly one third of its value against the euro and U.S. dollar since the euro peg began in September.

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