EUR/CHF – Most Dangerous Trade in The World?

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Complacency is always dangerous in business and never more so than in the currency market where fast moving policy actions could very quickly upend the very best laid plans. For the past six months the single least volatile pair in the currency market has been the EUR/CHF cross which has marked time near 1.2000 level for countless days on end. The absolute absence of any movement has been the result of central bank intervention with Swiss National bank flatly announcing to the market that it is willing to buy “unlimited” quantities of foreign currency in order to maintain the 1.2000 barrier.

Over the past nine months the SNB has staged one of the most successful intervention operations in currency market history by convincing some the largest speculators in the world that it has full control of the market. It has gone to extraordinary lengths to maintain its power in the FX market, opening up credit lines of 1 Billion dollars each with more than 100 interbank counterparties in order to make sure that its 1.2000 bid remains inviolable.

Masters of Manipulation

The move has not only been a masterful financial coup, but has provided much needed relief to the export driven Swiss economy. As a result of the SNB actions, Swiss economy continues to grow albeit gradually while the country enjoys the lowest unemployment rate in the industrialized world. The latest GDP figures showed that Switzerland expanded at 0.7% rate versus 0.0% forecast.

This intervention has taken place against an increasingly unstable background in the Eurozone with focus now moving from the smaller peripheral southern economies of Greece and Portugal to much more integral EZ members such as Spain and Italy. Concerns are mounting that the currency union may not survive. The Eurozone nations find themselves in an intractable position of having a single inflexible currency and no formal means for transfer payments. The result has been the compounding of more and more debt on the weakest members of the region along with policies of fiscal austerity that only exacerbated the region’s economic problems.

At this point many market analysts are convinced that the EUR/USD in its present form cannot survive unless the member nations agree to a more federated union with intra-national taxing and bond issuance authority. If the European policy makers adopt the more integrated than the pair will likely stabilize, although even in that case the adjustment process could weaken the currency materially as the necessary rebalancing takes place. If however, the political differences prove to be insurmountable and the euro approaches the point of fracture the downward pressure on EUR/CHF will become immense as capital flight becomes rampant.

Speculators Line Up

The amount of speculative and real money flows that will be directed into the Swiss franc will be enormous and will in all likelihood overwhelm the SNB. The history of central bank interventions has taught us that they all fail in the end. This was true with the Bank of England’s losing attempts to remain within the European Stability Mechanism in the early 1990’s. It was true with Bank of Japan’s endless interventions to weaken the Japanese yen and its been true countless times in many emerging market nations from Argentina to Thailand.

Up to now the SNB has engineered the longest and most successful currency intervention in modern times. However, the next few months could prove particularly turbulent for the euro and the Eurozone economy. If Spain and then Italy are shut out of the sovereign debt credit markets the risk aversion flows may overwhelm the carefully constructed EUR/CHF peg. In that scenario the SNB may resort to extraordinary measures such as capital controls and negative interest rates to discourage speculators from flooding into the franc. But with most analysts setting the true market value of EUR/CHF at closer to 1.0000 rather than 1.2000 the peg may ultimately prove to be too difficult to defend.

Boris Schlossberg
Managing Director

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