The Swiss are getting impatient with their stubbornly strong currency. Ever since establishing a peg to the euro and a floor at 1.20 for EUR/CHF two months ago, the euro has not gained much more over the Swiss franc.
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EUR/CHF has made little progress since the peg
The latest proposed remedy is to tax offshore deposits and perhaps even return to negative interest rates. The Guardian noted that “negative deposit rates were imposed as the Swiss battled a red-hot currency in the 1970s, but they did little to weaken the franc.” Negative rates have been proposed multiple times but Swiss National Board (SNB) board member Jean-Pierre Danthine and SNB Chairman Philipp Hildebrand on separate occasions have each recommended against taking such actions. Regardless, currency markets must be on edge again over the prospects of another massive decline in the franc’s value.
I never cease to marvel at the difficulty some countries have in devaluing their currencies. Ben Bernanke once noted that it must always be possible to devalue a currency, otherwise a central bank could print enough paper to buy up all the assets of a given country (or countries even). In other words, eventually the market has to “wise up” and destroy a currency that is getting printed in such quantities. On the other hand, this is currently a world that includes competitive devaluations, so currency traders often chase the “least bad” options.
EUR/CHF has been hindered by persistent weakness in the euro. For example, since the peg, the euro has lost around 5% against the U.S. dollar. The Swiss have hitched their currency to a sinking ship, and the franc simply has not been able to submerge fast enough to keep pace.
So, how to trade this setup?
The on-going and looming downside potential in the euro means that playing franc devaluation with EUR/CHF presents notable downside risks. Instead, going short the franc against other currencies may present a more palatable strategy.
An interesting hedge then is to short EUR/CHF in combination with longs in the U.S. dollar, British pound, and even the Australian dollar against the Swiss franc (USD/CHF, GBP/CHF, and AUD/CHF, respectively). If the euro plunges significantly (or even falls apart), the short in EUR/CHF should profit. To the extent the Swiss are still trying to manage a peg during the euro’s decline, all three of the franc shorts should profit as well. Moreover, traders fleeing for safety are likely to converge on the U.S. dollar.
If the euro soars from some good news, I imagine it will also be good for the British pound and the Australian dollar, providing some cushion to the downside risk in this trade setup. Playing all three pairs also mitigates against the risks inherent in each of the constituent currencies: the U.S. dollar’s long-term secular decline, on-going quantitative easing by the Bank of England, and the potential for commodities to decline significantly and take down the Australian dollar.
More active traders can even use this strategy to trade in and out of one or more of the franc shorts on an intraday basis to manage risks more tightly.
Be careful out there.
Additional disclosure: I am also short EUR/CHF, long USD/CHF; planning to go long AUD/CHF and GBP/CHF again; planning to sell position in FXF