Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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The market consensus is for further EUR/CHF depreciation
Christopher Dembik
Head of Macroeconomic Research
- This is also our case with a long-term target of 0.9410.
- The recent break of the 0.9700 support zone is an important signal that selling pressure will persist.
- A minority of market participants expect the euro to rebound in the second half of the year (e.g., Commerzbank has adjusted its price target for EUR/CHF upwards to 1.05). In our view, there is no evidence to support this scenario, whether based on fundamentals or technical market elements (such as key levels, flow trends etc.).
The interest rate differential and the geopolitical risk are usually the two main markers for the Swiss franc. The year 2023 is no exception to the rule. For the time being, the geopolitical risk is reduced. We doubt that the situation in Ukraine will deteriorate sufficiently to cause a return of volatility in exchange rates. The risk of a US default could create volatility. In 2011, when the U.S. was facing a similar situation, the Swiss franc was the biggest winner ahead of the Japanese yen, rising 7%. Traders looked for hedging tools and obviously the Swiss franc came out on top. However, history does not always repeat itself. Negotiations on raising the cap are going to be very difficult, that's for sure. On the other hand, currently it is not an element of additional volatility in the market. The closer we get to the June 1 deadline for a deal (some are starting to talk about June 15!), the more erratic we could see currency movements. However, for now, it's all quiet on this front. The rate differential is most important at this point. There is a clear correlation between the interest rate differential between Germany (the benchmark for the Eurozone) and Switzerland - see chart below. The wider the spread, which also reflects the different monetary policy stances and risk perceptions of market participants, the more the EUR/CHF tends to depreciate. This movement is unlikely to stop in the short term, especially because the Swiss National Bank is expected to tighten its monetary policy longer than the European Central Bank.
Technical analysis also points to a depreciation of the EUR/CHF. Since the beginning of the year, the pair has lost 2.11%. It is moving below a descending oblique. In addition, it is currently below its 50-day (green line on the chart below) and 200-day (purple line) moving averages, both of which are around the 0.9840 area. During the session on Monday, May 22, the pair temporarily broke through the support zone at 0.9700 (the third time was the charm). This opens the door for a decline in the price with a risk of reconnecting with its low point at 0.9410 in the long term.
The fall in the EUR/CHF will not be linear, however. The current positioning of traders and institutional investors could slow the speed of depreciation. According to the Commodity Futures Trading Commission's latest Commitment of Traders report, traders are neutral on the CHF. In the week leading up to May 16 (the latest data available), traders were slightly more positioned to sell than to buy, but only marginally - see chart below. This is not a differentiator currently.
To summarize, the environment remains favorable for a decline in the EUR/CHF with a low around 0.9410. We doubt that there is enough momentum to go lower in the coming months (bearing in mind that the main support area is then around 0.9360). The interest rate differential is expected to be the main driver of the pair's depreciation. The geopolitical risk should not be a particular marker in the short term (few risks not taken by the market). The only point of uncertainty on the macroeconomic front is inflation. We believe that many, if not all, central banks have misjudged the extent to which inflation is largely structural. Those that have or will soon be taking a break from monetary policy could be in for some surprises later. As an example, we could witness what is happening in Canada. The Bank of Canada was one of the first major central banks to take a break thinking that inflation was under control. In the end, it's been rising again for the last three months. This is something to watch closely and will certainly be watched by the Swiss National Bank, which is so concerned about inflationary pressures.
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