Swiss Franc Most Exposed in G10 to Downside Risks if Greenback Gains Continue

Swiss Franc Most Exposed in G10 to Downside Risks if Greenback Gains Continue

 Published: August 13th, 2021

This week, the Swiss Franc has led a laggard group of G10 underperformers. That's bad news for CHF bulls, but things could get worse if an analysis by BofA Global Research is borne out in the coming weeks and months. They say the franc is the one currency most exposed if the current recovery in US bond yields continues.

While the potential for changes to monetary policy settings by the Federal Reserve (Fed) has been on investors’ radar since the closing months of 2020, US bond yields have been on a downslide as the market seemed to judge that any change in direction by the world’s leading central bank was unlikely in the short term.

That view looks to have shifted in the past few weeks and most notably before last Wednesday's PMI numbers were released by the US Institute for Supply Management.

A jump in services sector orders hinted at another acceleration of America’s economy early in Q3, an idea given a further fillip by last Friday’s sizzler non-farm payrolls report. It showed the US economy creating or re-activating close to a million jobs lost to COVID-19 restrictions for the second consecutive month.

As America’s job market moves closer to hitting the Fed’s milestone of ‘substantial further progress’ toward full employment, the possibility of a September announcement by Powell and the bank’s FOMC council about a tapering of the USD 120 billion-per-month QE programme looks more and more likely.

Following months of calm in US and global bond markets, investors have taken notice, and it’s started dragging down the franc.

'In our view, a clear pattern is emerging, and if the trend in global fixed income carries through August, then CHF looks to be the top laggard in G10 forex,’ said strategists at BofA Global Research.

‘The charts suggest EUR/CHF could see a correction and return to the 1.10 level. However, there is no suggestion of sustained outperformance, in our view, without parallel outflows from Swiss equity and bond markets. For those reasons, our focus is on lower CHF vs USD.’

CHF gains still possible, but headwinds remain

The firm goes on to say that a EUR/CHF recovery toward 1.10 might be feasible. However, ‘the more meaningful moves’ are likely to be against currencies like the New Zealand dollar, Norwegian Krone, and the Canadian dollar, possibly adding the British pound to the list.

Switzerland has the world’s lowest official cash rate, which typically translates into low bond yields. That distinction leaves the franc exposed to increases in interest returns paid to holders of other countries’ debts.

As BofA puts it, the Swiss National Bank (SNB) ‘has maintained a consistent direction for some time, and short-term changes to forex markets aren’t expected to change the bank’s narrative. If the yields stability seen this week turns out to be a precursor to more gains, we believe CHF is the G10 currency most vulnerable to a yield reset.”

Dollar rates have risen across the board in the past week in parallel with a rise in the all-influencing two-year US government bond yield, which has experienced an uplift of almost a third to 0.21 per cent in the week up to Wednesday 11 August, pushing the USD/CHF exchange rate to leap up more than 2 per cent from the lowest levels seen since June.

That was when the Fed first started signalling that it might consider making adjustments to its quantitative easing and related interest rate policies at a pace more accelerated than previously thought.

The only greenback decline amongst the G10 contingent of majors during the past week was against the New Zealand Dollar (NZD), which has benefited recently from rising anticipation that the Reserve Bank of New Zealand (RBNZ) could raise its interest rate as early as 18 August.

Currencies and yields

JP Morgan’s London forex desk said in a morning commentary on Thursday that the franc continues to under-deliver with EUR/CHF and USD/CHF both seeing solid gains through this week’s session. ‘The cross seemed to locate a base of 1.0719 this week after being unexpectedly heavy for the last four weeks, a pattern that confused many CHF observers.’

‘That’s one reason why USD/CHF has been a net gainer benefitting from the recent change of tone at the Fed as positive US economic data continues to pile up. The downtrend is being challenged from YTD highs, and we are running cautiously-optimistic USD/CHF longs going into the next round of US CPI data.’

While CHF has been a big currency markets under-performer this week, the Swiss franc had previously been a gainer when US government bond yields were downshifting. Combined with an upswing in consensus expectations about inflation levels, the franc’s real-term yields have been less enticing to investors.

Many analysts have linked those declines to the recent surge in delta variant COVID-19 cases across large parts of Asia and earlier doubts about whether the Fed was really set to announce monetary policy changes in the near term.

It’s conceivable that both had previously combined to influence bond yields downward and nudge the franc to its highs. It’s also conceivable that global economic headwinds coming from China could mean some degree of traditional safe-haven demand for francs will linger, and ultimately serve to minimise any declines.

‘If yield compression is behind the re-pricing in Chinese growth prospects, then they move in CHF makes more sense seen in that context,’ BofA’s analysts say. ‘While the recent shift in fortunes has to be seen as one outcome of system-wide declines, the uptick in actual yields has held CHF back, to the extent that the franc has led the pack of G10 underperformers this week.’

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