USD/CHF: October Outlook

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Includes: FXE, FXF, UDN, UUP
by: FX Empire

The early September announcement by the Swiss National Bank of a floor on the Euro/Swiss weighed heavily on the Swiss Franc across the board, giving the U.S. Dollar a boost while reducing the Swiss Franc’s appeal as a safe haven currency.

One of the attractive features of the Swiss Franc is the currency’s appeal as a safe haven asset. During the height of the European sovereign debt and U.S. debt ceiling/budget deficit problems, investors flocked to the Swiss Franc for protection because of its ability to be a store of value. The pronounced uptrend in the Swiss Franc attracted speculative traders who drove the currency higher and added excessive volatility.

Not only did the Swiss National Bank become concerned that the higher priced Franc would mean lower demand for Swiss exports, but the increase in volatility was causing excessive price swings. This affected the way that Swiss businesses conducted themselves since they could not make accurate price forecasts for production and budgeting.

Sensing a crisis of its own if it didn’t take action immediately, the SNB made the announcement to put a floor on the EUR CHF. This triggered the strong rally in the USD CHF since the Dollar became the last real viable safe haven alternative left. The move by the SNB drove speculative traders out of their long Swiss Franc positions while encouraging investors to shift their funds to the U.S. Dollar almost immediately. Since then a solid uptrend has developed as the SNB followed up its announcement with a vigorous threat to aggressively defend its position.

Based on the action by the SNB there will probably be limited chances for a rally in the Swiss Franc which means the long side of the USD CHF is likely to continue to be a safe trade. In addition, with both the central bank set on keeping interest rates low, the interest rate differential is not likely to be an issue for traders to consider. Therefore the movement in the USD CHF during October is likely to be triggered purely by the U.S. Dollar’s strength or weakness.

To understand the aggressive move by the Swiss National Bank, one has to understand the SNB’s monetary policy strategy. Firstly, the SNB is most interested in price stability. Secondly, it will base its monetary policy decisions on a medium-term inflation forecast. Finally, it will set an operational target range.

The first SNB mandate, price stability, is viewed by the central bank as an important condition for growth and prosperity. The rapid appreciation by the Swiss Franc versus the Euro was attempting to challenge this price stability. The central bank was forced to take a preemptive strike against the strength of its currency from pushing its economy into recession. By seeking to keep its prices stable, the SNB is attempting to create an environment in which the economy can fully exploit its production potential. The stunning appreciation in the Swiss Franc was a direct threat to the SNB’s price stability mandate and the central bank felt it had to act aggressively now or it would lose control of the situation.

After failing several times over the past few years to intervene successfully in an attempt to devalue its currency, the SNB needed to make a statement to speculators that it would not tolerate this meteoric price appreciation in its currency. Records show that the central bank may have lost as much as $20 billion Swiss Francs in conventional interventions. Time will tell whether the pegging of the Swiss Franc versus the Euro will have lasting results. At this time it has definitely helped trigger a strong rally in the USD CHF that is expected to continue throughout October.

The real questions are how long will the SNB be willing to defend the Swiss Franc and how much money are they willing to burn to back its decision. Looking back, when the global economy was in turmoil investors seeking protection really had no choice but to use the Swiss Franc as a safe haven currency. A strong economy, low inflation, and low unemployment are the main reasons for its attractiveness. These factors still exist except this time the central bank will be keeping a more watchful eye on trading activity in an effort to control its currency appreciation.