Two weeks ago, I wrote "Time To Short The Franc… With The Euro" as a trading call that combined the likely continued strength in the euro (FXE) and the likely continued weakness in the Swiss franc (FXF). I was looking for a pullback in EUR/CHF to get started, but instead the currency pair continued to push upward sharply. For 6 out of 7 trading days, EUR/CHF relentlessly rose until hitting 1.25688, a 20-month high. This was "only" a move of 4.0%, but relatively large for EUR/CHF. There are several indications that this is just the beginning.
The third outburst is a charm, as it briefly sends EUR/CHF above the presumed near-term target level of 1.25
On January 15th, UK Reuters reported:
"…one-year risk reversals are turning in favour of the euro, indicating that the Swiss franc's weakness could be prolonged.
The one-month euro/Swiss franc risk reversal was traded at a premium of 2.5 vols in favour of a stronger euro on Tuesday, rising from around 1.4 at the start of the week. One-year risk reversals have fallen sharply, showing only a marginal bias for euro weakness and could flip to reflect euro strength soon.
'Risk reversals haven't been this skewed in favour of euro calls in the last 10 years,' Kit Juckes, currency strategist at Societe Generale said in a note."
The chart above shows that there have now been three strong bursts of buying since September when EUR/CHF first moved off the 1.20 floor set by the Swiss National Bank (SNB). Each time, the buying has reached extremes as defined by the short-term volatility for EUR/CHF (for the technically minded, see how many days EUR/CHF traded well above the upper Bollinger Band). These moves resemble a rush to unwind many months of a bias toward a strong franc. EUR/CHF finally pulled back starting January 18th, but the move was shallow: it ended in four trading days and only retraced 40% of the previous gains. EUR/CHF did not even drop to its 20-day moving average (DMA). In other words, the upward bias remains strong.
I took careful note when on Hard Currency on January 13th, Michael Sneyd, foreign currency analyst at BNP Paribas, estimated a long-term fair value around 1.40 to 1.45 for EUR/CHF. However, like so many analysts, he only forecast a rise to 1.25 by the end of the first quarter. The ability of the pair to hit and surpass that level so quickly is likely forcing many to re-evaluate their models for timing when EUR/CHF gets back to "fair value."
At this point, it is very difficult to imagine EUR/CHF rallying so high simply because the eurozone has been under stress for so long. Just last month, Adam Cole, foreign currency strategist at RBC Capital Markets, stated on Hard Currency that while the franc was "clearly over-valued", traders would get bored with the franc trade for the time-being. At that time, traders appeared disappointed with the SNB's Q4 statement on monetary policy, which did not include the introduction of negative interest rates that some banks have begun to implement on franc deposits. Those who are able to shift gears the most quickly will likely benefit the most: sharp changes in sentiment can unleash powerful forces.
Certainly, SNB Chairman Thomas Jordan is not satisfied with the current rally. On Friday, January 25th, Jordan reiterated the SNB's position that the franc remains over-valued. The SNB also stands ready to continue weakening the franc. From UK Reuters (emphasis mine):
"The Swiss National Bank continues to keep all monetary policy tools at the ready to keep the still strong Swiss franc in check, chairman Thomas Jordan said in televised comments on Friday.
'We don't rule out using any monetary policy instruments should they become necessary,' Jordan told Swiss broadcaster SF DRS in an interview. However, he said the SNB expects the franc to continue its recent weakening…"
Jordan did not say whether the SNB will consider raising its floor, but Sneyd provided a good reason to suggest that the SNB will consider raising the cap too costly. Raising the floor would require increasing reserves. In just Q3 of 2012, the SNB accumulated $80B more in reserves (a 70% increase). Euro holdings essentially stayed flat as the SNB scrambled to diversify into other currencies. Sneyd guesses that the SNB will hold reserves around current levels until the franc reaches its long-term fair value. With the current dynamics, "long-term" may not take as long as one would expect.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in FXF over the next 72 hours.