The Swiss Central Bank (SNB) interest rate decision this past Thursday continued to indicate the central bank's discomfort with the current exchange rate. From the statement:
The Swiss franc is still high. An appreciation of the Swiss franc would compromise price stability and would have serious consequences for the Swiss economy.
This discomfort is understandable when examining the Swiss Franc (NYSEARCA:FXF) on a longer term time frame.
After trading for a range around 1.55 for many years, the EURCHF began to appreciate in 2007 in the broader rush to safety that was also experienced in the USD (NYSEARCA:UUP) and Japanese Yen (NYSEARCA:FXY). This rush to safety brought the CHF close to parity with the Euro, at which point the SNB implemented its 1.20 minimum exchange rate for the EURCHF (NYSEARCA:FXE).
This historically high value of the CHF is having serious consequences for Swiss inflation, which is expected to be -0.3% in 2013. Therefore the Swiss are one of the few countries in the world experiencing deflation, contrary to the SNB mandate. Adding to SNB concerns is that the expected inflation rate has been revised down since March 2013, indicating the SNB sees the situation worsening rather than improving.
A high value in the CHF can cause deflation, especially for a country like the Swiss with a high level of imports, as a valuable CHF makes imports less expensive, depreciating prices.
Source: Schweizerische National Bank
This deflation is having real effects to the economy at large, with Switzerland GDP flat since March of 2012. The blue line on the chart below is the Swiss GDP, the yellow line is the EURCHF exchange rate.
The 1.20 floor may not be enough.
The EURCHF has been in a downtrend since July 2012, with a large move from 1.23 to just above 1.22 since the selloff in the S&P500 (NYSEARCA:SPY) began. The sub 1.22 EURCHF range has been reached twice in the past 2 years, each time it was followed by a significant rally. I expect similar price action once the EURCHF reaches this range again.
The main concern I have with the EURCHF is that retail FOREX traders are heavy long it as well. Given that 80% of retail traders lose money, this usually isn't a good sign, but given the fundamentals and currency interventions by the SNB, I believe this is one of the few times they've got it right.
Large speculators and leveraged funds are just beginning to buy back into the CHF, which is a great sign as their size can push price action considerably.
With the 1.20 EURCHF floor not having the intended consequences for GDP or inflation, there is the potential for the floor to be raised in the future. Although retail FOREX traders like the trade, they are beginning to be joined by large speculators who can make a big impact on price action. With the 1.20 floor in place, the risk to reward scenario is fixed. This makes the EURCHF an attractive buy below 1.22, with a price target of 1.26, providing a reward to risk ratio of 2:1. If you set your stop loss below 1.20, the only question is how long you'll have to wait until you can sell the EURCHF at a profit.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FXF over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am actively trading FOREX and CFDs and may either be long or short the instruments discussed at the time of this article's publication. To see a complete list of my open trades in real time, visit mcnultycapitalmanagement.com.