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Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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EURCHF - trading the downside prospects
John J. Hardy
Chief Macro Strategist
EURCHF is on the move, having now traded to a new low since early 2017 on an interesting possible driver - the US Treasury earlier this week having placed Switzerland back on its list of potential currency manipulators. The implication here is that to avoid negative further attention from US policymakers, the Swiss National Bank (SNB) will have to exercise restraint in intervening against further CHF strength as it has done regularly since the traumatic revaluation of the CHF after abandoning the CHF ceiling exactly five years ago today in 2015. Removing the assumption of a powerful central bank leaning against the currency's strength could mean a significant repricing of the franc higher, particularly given that over the last couple of years, Switzerland's economy has managed quite well and has rebuilt its current account surplus back toward a more historically normal 10% of GDP by late last year versus as low as sub-7% in early 2018. A current account surplus operates to constantly appreciate a currency unless capital flows compensate by leaving the country.
Trading a stronger CHF via EURCHF
Traders looking to trade CHF from the long side now potentially have an altered playing field if the SNB steps back here and the market psychology changes around that new fact. Traders looking for a re-rating of CHF higher might consider EURCHF short trades as a preferred vehicle as EURCHF is the dominant benchmark for the CHF exchange rate. As the chart below shows, we have just broken to the lowest levels since early 2017 as the US Treasury this week placed Switzerland on the currency manipulator watchlist. Shorting here with a stop north of 1.0850 and a target below 1.0500 or even close to parity for a stretch target is one strategy, as any move back above 1.0850 would suggest that for now, this move lower has been a false break.
A second way to trade EURCHF downside over the medium term - especially for a more considerable move and in a way that allows a trader to maintain a position regardless of short term volatility - is via a EURCHF put option, for example, a 3-month (April 15) 1.0500 put option, which costs 29 pips (spot reference 1.0760). A higher break-even price can be achieved with a higher strike price but at a higher premium cost (1.0600 for same expiry costs about 45 pips - so breakeven near 1.0555 vs. 1.0471 for the 1.0500 put option at 29 pips.)
Chart: EURCHF weekly
Risk warning
One potential offsetting factor for CHF bulls is the idea that the SNB has become something of a sovereign wealth fund in its own right as 20% of its enormous reserves (overall reserves worth well north of 100% of Swiss GDP and having rocketed some 800% from pre-financial crisis levels and the SNB's investments saw enormous positive gains in 2019). This fact could act as a further driver for CHF strength in the event late CHF strength since December of last year has also been driven by the virtual melt-up in equity markets. But it can also mean sudden downside risk if the mood for risk appetite changes drastically - i.e., CHF weakening sharply and EURCHF rising quickly.
Only advanced traders with a thorough knowledge of the risks of trading options should consider an options trade in the FX market - the chief factor to consider in this case that any long EURCHF put option trade as outlined above can result in a 100% loss of the amount risk on buying the option.
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