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.
"Tied at the hip" sums up the cyclical relationship between the Swiss and German economies as well as the Swiss franc’s trade-weighted index (against a basket of currencies). The top window in the chart shows Swiss and German GDP and the fairly strong correlation between the two. Nearly 58% of Swiss exports go to Western Europe, with more than 15% destined for Germany. Not only has growth in Southern Europe dipped back into contraction, but Germany also is showing signs of a looming recession according to the IFO and ZEW surveys on business and investor sentiment, as well as the Purchasing Managers’ Indexes.
The middle window shows the expectations index of Germany’s IFO business survey and Switzerland’s KoF survey of leading economic indicators. Note how the franc held up during the 2007-2008 crisis despite the Swiss and German recessions. From October 2007 (the peak for equity indexes) to March 2009 (bottom of equities), the franc’s trade weighted index gained 15%. Considering the SNB’s active role in stemming franc strength, the currency likely will suffer during the next phase of macroeconomic deterioration in Europe. Considering the Swiss franc’s tendency to underperform during rising global equities, the currency will remain pressured for as long as stocks continue to avoid breaking below key support levels: 10,200 in the Dow, 1,100 in the S&P 500 and 4,780 in the FTSE-100. But any violent sell-off in equities brought about by events such as failed European bond auctions, ongoing disagreements over debt terms or new waves of sovereign downgrades likely will prop the franc against non-EUR currencies only temporarily. Such events could be exploited by traders to sell the franc on each bounce.
Our favorite pick against the Swiss franc would be the Canadian dollar because of ongoing volatility in oil prices stemming from Mideast uncertainty. Aside from the energy argument sustaining the loonie, any surprise bounce in U.S. growth is likely to help loonie sentiment. CAD/CHF is seen extending gains towards 0.96 from the current 0.90, with support cropping up at 0.88. An alternative but similar trade would be to combine longs in USD/CHF with shorts in USD/CAD.
Ashraf Laidi is an independent strategist and author of "Currency Trading & Intermarket Analysis." His Intermarket Insight appears daily on AshrafLaidi.com.
