The case for Swiss franc weakness

EUR/CHF has continued to hug the 1.2000 ‘line in the sand’ enforced by the Swiss National Bank. CHF currently shows little sign of weakening although we continue to see risks of a higher EUR/CHF. Against the USD the CHF has been similarly stable but we look for USD/CHF to move higher eventually. The main imponderable is the timing of CHF weakness. Ongoing Eurozone doubts even after the agreement of a second bailout for Greece mean that the CHF remains a favoured destination for European money.

The outlook for EUR/CHF will depend on how the situation in the Eurozone develops. The recent agreement for a second Greek bailout received a muted reaction from markets, and there is a long way to go before confidence towards a resolution of the debt crisis can be fully restored. Assuming that there will be an eventual improvement in risk appetite, CHF will weaken given the strong correlation between EUR/CHF and risk over the past three months.

EUR/CHF has enjoyed a strong relationship with movements in interest rate differentials over the past few months, with both bond yields and interest rate futures. This implies that it will take a relative rise in German yields versus Swiss yields for EUR/CHF to move higher. This is certainly viable given the deterioration in Swiss economic data over recent months. Indeed, as reflected in the KoF Swiss leading indicator and manufacturing PMI data, the economy is heading downwards.

The threat of deflation has also increased in the wake of unwelcome CHF strength, which has left the currency extremely overvalued according to our measures of ‘fair value’. Growth will be weak this year but the economy may just avoid a negative GDP print. Against this background Swiss bond yields will remain low, along with policy rates. While the outlook for the Eurozone economy is not much better, bond yield differentials between the Eurozone and Switzerland are likely to widen, which will eventually help lead to a higher EUR/CHF exchange rate.

My blog posts will be less frequent over coming days as I am on a business trip to New York. Happy trading.

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