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USD/CHF Remains Bearish As Global USD Demand Remains Relatively Weak

by: Hedge Insider
Hedge Insider
Long/Short Equity, Value, Macro, volatility

USD demand has softened considerably in recent times, perhaps most importantly relative to EUR.

The euro has ascended on the back of markets pricing in a lower premium into the U.S. dollar, as risk sentiment remains positive.

With market risks reduced, and interest rates very low across the board (at least across G10 FX), EUR/USD still has plenty of room to move higher.

Given the positive correlation between EUR and CHF, we should expect to see further USD/CHF weakness. While both USD and CHF are safe havens, USD appears most vulnerable to downside (in line with the current trend).

The USD/CHF currency pair, which expresses the value of the U.S. dollar in terms of the Swiss franc, has pushed lower recently as Swiss franc demand has proved more robust than the demand for U.S. dollars. In a recent article of mine, I noted that the 0.9250 level remained in sight (when the market price was just over 0.9400. Since then, USD/CHF has taken the 0.9250 level, and fallen even further to take out its March 2020 low (see chart below).

USD/CHF Daily Candlestick Chart for 2020(Chart created by the author using TradingView. The same applies to all subsequent candlestick charts presented hereafter.)

The drop below the March low may not (in itself) be an important signal, as markets do often gravitate towards levels such as these which typically attract plenty of stop-loss orders. Popular stop-loss/take-profit levels can generate liquidity, as orders are automatically closed out at these levels. When these levels are taken, this can also generate further volatility in the same direction (which is why it is usually not a good idea to place stop-loss or take-profit orders "only slightly" away from these more obvious levels).

Yet the move lower, below the March 2020 low of circa 0.9182, could signal further selling interest. However, the EUR/CHF chart perhaps proves that it is not necessarily CHF strength that is dragging USD/CHF down, but rather USD weakness. If it were CHF strength, we would expect EUR/CHF to also be falling, but this is not the case (as shown below).

EUR/CHF Daily Candlestick Chart in 2020While EUR/CHF has fallen in the most recent trading range illustrated on the chart above, during the same recent period through which USD/CHF has fallen, EUR/CHF has been rising. At worst, EUR/CHF is consolidating, and at best it is staging a minor rally. In other words, CHF is not globally strong, rather USD is globally weak; a look at the EUR/USD chart is another proof of this (below).

EUR/USD Staging a Comeback in 2020The almost unidirectional chart above shows EUR/USD staging a clear comeback. The pair has clearly exceeded the reactive high that was found in March 2020, which was produced by falling global equities and a sharp, mechanistic demand for euros, as short-EUR and "leveraged-long U.S. equity" positions were unwound. As discussed in a recent article of mine, markets are pricing in a lower USD premium as traders and investors question the carrying value of U.S. dollars in light of high liquidity, reduced market risks, and U.S. rates now at the zero lower bound.

The U.S. Federal Reserve's current short-term rate remains at a target range of 0.00-0.25%, which is not too far away from the deposit facility rate of the European Central Bank (often used as a comparable rate) of negative -0.50%. In other words, with a high USD premium still priced in (in terms of purchasing power parity, as discussed in my previous article referenced) and yet very little carry-trade appeal (due to the tight interest rate spread) means EUR/USD still has plenty of room to push higher. A significant U.S. bounce-back relative to Europe, and/or a significant shock to European political or economic stability, would likely be needed to reverse this course.

Of course, we could see the trend slow down, with levels consolidating in the shorter term. But if we think about the longer-term prospects of EUR/USD, there is no significant reason why the pair could not find similar levels as found in early 2018 (above the 1.24 handle).

EUR/USD vs. 2018 HighsPerhaps EUR/USD could go much higher than 1.24, but 1.24 is a starting point for bullish prognosticators. I would lean on this potential myself, as interest rates are likely to hold steady for the foreseeable future while the possibility of the United States significantly outperforming Europe is unlikely for at least the next 12 months. The U.S. continues to fight the COVID-19 pandemic (we might argue in a not-so-organized or impressive way), and the pandemic is indeed likely to remain relevant into 2021. I believe there is enough time for EUR/USD to push higher still.

DXY, the U.S. dollar index, is heavily skewed to EUR (in terms of measuring USD's international value). While this is somewhat outdated (based on historical international trade), the importance of EUR still remains very important to USD value. The euro is the second-most demanded world reserve currency after USD, and as such a stronger euro is likely to reflect USD weakness across the G10 FX space (and often beyond).

EUR tends to correlate with CHF too, especially as Swiss National Bank interventions attempt to soften moves in this exchange rate (which is important for the Swiss economy, in terms of their export competitiveness). So, with a stronger euro, we would expect a weaker U.S. dollar relative to the Swiss franc (all else equal). Given that European sentiment is improving overall, with CHF weakening relative to EUR too, we would expect further USD/CHF weakness but this being moderated by weaker safe-haven demand (CHF is considered a safe haven, just like USD).

Risk sentiment is largely still constructive, especially with extremely low interest rates driving investors into non-cash instruments (including equities), likely in part in an effort to protect their purchasing power. Positive risk sentiment reduces safe-haven demand, but low (or negative interest rates) could also help to reduce CHF liquidity (likely more than USD liquidity), since the SNB's rate remains the lowest among the G10 nations, with a short-term rate of -0.75%. Negative rates are essentially a tax on liquidity and can (somewhat paradoxically) increase the values of these currencies since liquidity can drop as investors seek alternative ways to park their cash (such as in positive-yielding assets, like equities).

The interest-rate outlook for USD/CHF is likely to remain in favor of USD, but in terms of spot prices, we might even bias CHF over USD. In any case, even with a neutral view, EUR/CHF is likely to remain fairly steady within ranges; yet with EUR/USD strength, we would probably continue to expect USD/CHF to give up further room to the downside. This is not a short-term outlook, as short-term adjustments may stage minor rallies, but a gradual decline to the 0.8300 level (last seen in January 2015) for USD/CHF is not off the cards.

USD/CHF vs. January 2015 LowThis is bearing in mind that USD/CHF is already trading below its 2018 lows and indeed in line with the lows of 2015 (excluding January 2015, the month in which the EUR/CHF was broken, which created a sharp readjustment that favored significant CHF strength, which was unfortunate for the Swiss economy). Without a significant change to the status quo, USD/CHF would appear to remain bearish longer term.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.