Submitted by Saxobank's Steen Jakobsen via TradingFloor.com [15],
In a nutshell: The chance of EURCHF breaking the peg at 1.2000 have increased from 10% to 25-30% based on European Central Bank monetary policy, geopolitical risk and a lack of policy choices for the Swiss National Bank. This means that the weighted risk is now 9 figures – significantly up from 2 figures when I did a similar calculation back in 2011/12. ((1.2000-.9000= 30 figures) x 30% = 9 figures of risk) .This means that being long EURCHF no longer is a safe bet and although the 70% chance of the floor being both defended and protected is still high, the tail-risk involved is becoming to concerning.
[16]
Swiss Franc feels the love
It’s been a while but now the Swiss franc is yet again the world’s currency of choice. Back in September 2011 Swiss National Bank, SNB, introduced a floor at 1.2000 to the euro. Ever since, EURCHF has traded in a narrow range of plus or minus 2-3% but while geopolitical risk and desperate central banks have been ignored in energy, volatility and risk trading the Swiss Franc has once again become mighty.
There is a big difference from 2011/12 to now. Back then, the SNB reacted to a currency strengthening from 1.5000 to the euro to 1.2000 and then down to 1.0000. The import lines were massive and deflation was a real risk for a central bank known for its inflation targeting.
Today Switzerland runs a 10% current account surplus with CHF 453 billion in reserves and excess liquidity of CHF 317 bn in the banking system. Dutch and pan-European banks are moving money out of the ECB at minus 0.1% to a Swiss bank still paying a positive rate. The liquidity richness creates a massive bubble in housing and any other traded Swiss asset.
Meanwhile the ECB is indicating that it will engage full quantitative easing and even conduct a debasing of the euro. At least that is if you listen to Francoise Hollande and sometimes Mario Draghi.
To make things worse, the SNB has put itself in a corner. It’s hard not to say impossible to pursue: free capital movement, a pegged currency rate and trying to run an independent monetary policy at the same time.
You can run one or maybe even two, but not three. Just ask China, England before 1992 or any pegged currency central bank.
Three choices
1. Let the floor go…
2. Adjust the rate down slowly if capital inflow and revaluation continues
3. Accept further bubble like housing and equity markets.
To let the floor go directly without a fight is not going to happen. SNB President Thomas Jordan underlined the commitment in NZZ am Sonntag: ‘the peg is absolutely central to ensure adequate monetary policy in Switzerland – economic outlook having deteriorated. "
From a historical perspective, few pegs work. Just ask the Bank of England – I am old enough to remember the unpegging of GBPDEM – mind you – we all wanted to sell GBP, not buy it!
When you fix anything in an economic system you reduce your amount of freedom. Ironically the SNB has limited its own freedom voluntarily by pegging its currency. Now the anchor currency, the euro, desperately needs to weaken due to its own limitation. One euro for a vastly different Europe. It’s from this inability to move both in Switzerland and in Europe, that the bigger risk stems for EURCHF traders.
The timing of course is everything – the pressure is building week by week, but personally I doubt anything happens before the AQR – the asset quality review of European banks. I know for a fact that privately, SNB officials are concerned about the results and in particular for the German banking sector, so a strong CHF was expected, but not this early.
SNB is no longer alone in deciding whether the EURCHF pegs stays, it depends on ECB, Draghi, Vladimir Putin, and a number of other factors outside its jurisdiction. That’s the real difference and the real risk in EURCHF.
There is nothing more beautiful than love except when it’s unwanted.
