Given the uncertainties enveloping both the US and Europe safe haven and various emerging market currencies have looked increasingly attractive. Currencies that remain on top in the current environment are the CHF and to a lesser extent the JPY, much to the chagrin of the Swiss and Japanese authorities. Indeed, in reaction to unwanted CHF strength the Swiss central bank, SNB unexpectedly cut interest rates and said it will increase CHF liquidity to the money markets. The CHF fell in the wake of the announcement but the impact may prove short lived.
Both the JPY and CHF have registered a strong correlation with risk aversion over the last 3-months, strengthening as risk aversion has intensified. In particular, the CHF has been the best performing major currency this year and shows no sign of turning around despite the fact that it has already strengthened by around 21% against the USD and over 12% against the EUR. The Swiss National Bank had even ceased from intervening in the currency markets given the lack of success and pain on the SNB’s balance sheet.
The Japanese authorities last intervened in the FX market in March 2011 following the devastating earthquake in the country. However, despite the fact that the JPY has strengthened after a brief period of success, the authorities have been reluctant to intervene since. The major explanation for a lack of intervention is that the Japanese authorities blame the drop in USD/JPY on USD weakness rather than inherent JPY strength. A more accurate reason is that the yield differential between the US and Japan has narrowed, leading to JPY strength versus USD while more recently rising risk aversion has pushed the JPY higher.
I am bearish on both the CHF and JPY over the medium term but clearly any drop in these currencies is taking longer than initially anticipated. Higher relative yields taken together with some normalisation in risk appetite will help but the risks at present are still skewed for further CHF and JPY strength in the short term given that risk aversion remains elevated. The fact that peripheral bond spreads in Europe have continued to widen will only raise the attraction of the CHF as a safe haven currency so despite the SNB’s new measures, it may do little to prevent further strength in the currency.