Swiss franc trading strategy

As we approach next month’s European Central Bank decision amid escalating probability for negative interest rates, the Swiss National Bank is closely monitoring the franc in the event of any unwanted decline in EURCHF, which could rag the pair back towards the 1.20 floor it set in September 2011.

Markets are widely expecting the ECB cut rates at its June 5 meeting, by reducing the refinancing rate by 15 bps to 0.10% and cutting the deposit rate by 10 bps to -0.10%. The marginal lending rate may also be cut by 25 bps to 0.50%. There is even the possibility that the ECB would announce an asset purchase programme of private assets such as asset-backed securities.

All these factors could trigger fresh selling in EURCHF and ignite unwanted franc strength in a disinflation-bound Switzerland.

SNB awaits Eurozone CPI & ECB

The SNB shall await the June 3^rd release  of Eurozone May CPI estimate, following 0.7% reading in April. The CPI figure would have to reveal further strengthening on the headline rate—such as above 0.9%–or the core rate to remain at or above 1.4%–in order for any possibility for the ECB to hold fire. Such a scenario may prove shocking for market players who have interpreted Draghi’s May conference as a green light for June action, in which case would trigger violent bids in euro.

Don’t discount the surprise element

If the CPI figures maintain expectations of an ECB cut, then euro weakness may widen across the board on anticipation of action later that week. But the extent of any euro sell-off and unwanted rally in the franc would largely depend on the surprise element at the June 5^th conference– Will an ECB  rate cut in all three rates ends up being priced in the market? Will Draghi deliver a rate cut as well as MBS purchases? Or, will he cut only the refi rate? There is much room for upside (and downside) surprise, all of which will depend on the CPI data, the Thursday announcement and the subsequent press conference.

Low yielding franc

Is the SNB anticipating any euro-negative scenario by intervening in FX via selling of francs against EUR and USD? The franc has pared some of the gains accumulated earlier in the year on Russia-related safe haven flows.  Prospects for further CHF weakness may not only emerge from SNB jawboning, but also the deterioration in inflation data.

Switzerland and Japan have long swapped places for the lowest yielding 10-year government bonds, but with Japanese annual inflation reaching a 6-year high of 1.6% and Swiss inflation at 0.0%, the case for a falling yen against the franc can be based on lower “real” Japanese interest rates. Nonetheless, FX markets prioritise relative yields as well as anticipated rate of change. Since January, Swiss 10-year yields fell from 1.26% to 0.79%, while their Japanese counterpart remained near the 0.70%-0.60% territory. This explains the peak in CHFJPY and subsequent decline.

The EURCHF peg will likely remain at 1.20 without the SNB having to re-affirm it. More importantly, the value function is likely to emerge against CHF via GBP and USD. As the chart shows below, the recurring failures in the 100-DMA seen in USDCHF may be a thing of the past, which suggests that a breakout above 0.90 paves the way for sub-105 yen.