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Houston - We have a problem, in Switzerland

Bruce Krasting's picture




 

Houston - We have a problem, in Switzerland

Courtesy of Bruce Krasting

The ‘risk off’ trade is commanding the markets. A subtle, but interesting example is the EURCHF.

For four days the EURCHF has held to 1/8th percent away from the official 1.2000 peg. It sits at 1.2016 as I write.

Wherever you look, from China to Japan, to the USA, and the EU, trouble is brewing. As currencies go, there is no safe haven left. The Yen has benefited (as I anticipated, Link). There may be more Yen strength ahead as the market turmoil escalates, but I think that the Yen is no longer a safe place to hide.

On the other hand, Switzerland’s economy is doing very well, thank you. Its economy is growing and it has low unemployment. Thanks to an artificial exchange rate, (The Peg), it is still maintaining a trade surplus with its poorer neighbors.

There is evidence that money continues to poor into Switzerland. Six month T-bills are now trading at -25%. That the short end of the curve is trading at negative levels is not all that surprising, but the Swiss two-year went negative earlier today:

 

 

There is only one thing that can make the 2-year go negative. Demand. Hot money is getting converted into Francs, and then it is pushed forward in the swaps market.

The following is a slide of the EURCHF three and six months swaps.

 

 

Note that they are trading at a discount (left side larger than right). To determine the market price for six-month EURCHF, take the bid side (.0026) and subtract it from the current spot rate (1.2016)  - that yields 1.1990. This means that the outright six month forward EURCHF is trading below the 1.2000 Central Bank peg.

This slide looks at the one and two-year swap spreads. The implied outright forward EURCHF for one and two years are 1.1957 and 1.1792, respectively.

 

 

The swaps and bond market are showing that that money is coming into the Franc in a significant way. But the EURCHF has not touched on the magical 1.2000 level and there has been no reported Swiss National Bank (SNB) intervention. This does not add up.

Two possibilities:

1) Some very big (and ballsy) prop desk/ hedge fund is shorting the CHF to the market and using the negative cost of money as a carry trade to fund other investments. This is a beautiful trade as one is “guaranteed” not to lose money on the short CHF position because the SNB has “guaranteed” that the Franc will not exceed 1.2000.

While this is possible, I consider it unlikely. The negative cost of money may look attractive on paper, but there is no real guarantee from the SNB that the peg will last for the next two years. Money is cheap and available in other currencies all over the globe right now; there is no need to gamble the house to save another ½ percent on funding costs. If the peg were to break, that ½ percent savings would turn into a 20% loss. The risks and rewards of shorting the Swissie just don't justify it.

2) The SNB is involved with “sub rosa” intervention in the currency market. It may be using one or more banks (to make it look like commercial buying interest) to bid for Euros above the 1.2000 peg rate. Alternatively, the SNB may be offering EURCHF FX options to market makers.

I think #2 is happening. The SNB is quietly doing its best to avoid a visible and splashy round of intervention. If true, the SNB will have to back off in the near future and allow the Franc to trade at the 1.2000 peg. At that point it can be as aggressive as needed.

The EURCHF may be the tipping point for a new round of financial instability. I see this tipping into the dark side. I see this happening before week’s end.

ht/ms

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Tue, 04/10/2012 - 21:00 | 2333295 schatzi
schatzi's picture

My currency would be the Austrian Schilling. No idea what would happen with it though. I guess they'd peg it to the DM 7:1 like in the old days. Still staying in gold though. SEK & NOK too. Safest bet I can think of.

Tue, 04/10/2012 - 17:15 | 2332847 achmachat
achmachat's picture

which also means that our bank loans will be 25% cheaper overnight!
I love precious metals!

Tue, 04/10/2012 - 16:35 | 2332705 GOSPLAN HERO
GOSPLAN HERO's picture

I saw some nice silver Belgian francs on Ebay.

Get them.

Tue, 04/10/2012 - 15:33 | 2332368 bank guy in Brussels
bank guy in Brussels's picture

Very likely you're right and the Swiss would like to continue the quieter kind of intervention.

It will be hellish pressure on the Swiss if, as is likely, the ECB starts monetising debt wholesale and inflating, in order to save the euro project and re-balance the northern and southern euro-zone.

Might be better for the Swiss if Germany gets bold enough and could accomplish leading the north into a euro-exit ... SNB could then peg the Swiss franc to the new, higher-value German-led 'thaler' with less stress and pain.

 

Wed, 04/11/2012 - 05:00 | 2333862 Overflow-admin
Overflow-admin's picture

There's not much left in the pegging.
Soon the swissies will switch to begging.

"Watch the fires burning across the river" Sun Tzu

Tue, 04/10/2012 - 15:43 | 2332421 swissaustrian
swissaustrian's picture

We did peg the CHF to the DM in the late 1970s. The outcome was a massive wave of inflation in the mid 1980s. Not really a good choice either.

Sooner or later we'll have to discuss a Swiss sovereign wealth fund which invests fx reserves from interventions.

Tue, 04/10/2012 - 16:09 | 2332559 Clowns on Acid
Clowns on Acid's picture

Swiss soverreign wealth fund.....has been / will continue to buy gold and some silver.

Probably latest in defensive miliatry equipment as well.

 

Tue, 04/10/2012 - 16:54 | 2332786 Ratscam
Ratscam's picture

get your first two facts straight. They are fakes, the third one is planned, yes.

Tue, 04/10/2012 - 15:48 | 2332447 walküre
walküre's picture

I remember that. Didn't suit me well.

Tue, 04/10/2012 - 15:40 | 2332411 Zero Govt
Zero Govt's picture

".. the ECB starts monetising debt wholesale and inflating.."

Er, where have you been since December?

it's not "starts" it's started... BIG TIME

Tue, 04/10/2012 - 20:12 | 2333227 Imminent Crucible
Imminent Crucible's picture

Maybe there's no great mystery at all. Remember, the 1.20 peg was Phillip Hildebrand's idea----and he's history.

Tue, 04/10/2012 - 21:41 | 2333363 LongSoupLine
LongSoupLine's picture

...or his wife's idea.

Tue, 04/10/2012 - 22:05 | 2333394 Imminent Crucible
Imminent Crucible's picture

Well, yes. But they split the pot.

Thu, 04/12/2012 - 01:42 | 2336935 prains
prains's picture

her denial was to say the least quite "sweaty"

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