The Swiss franc is set to compete with the Japanese yen to be the currency of choice for investors seeking to fund investments in higher-yielding and riskier assets in coming months. The Swiss National Bank's dovish stance could see a recent franc sell-off against high-yielding currencies accelerate.
-- SNB's dovish stance adds to currency's funding status
-- Some fair value estimates show franc is overvalued
-- Swiss franc, yen may replace USD as main funding currency
The low yields offered by the franc, along with the Japanese yen, make it a favoured currency for funding carry trades - in which investors look to maximise gains in high-yielding currencies by borrowing in the lower yielders. Yen-funded carry trades have made a big comeback since the Group of Seven industrialised nations intervened to stop the yen appreciating after last month's earthquake and nuclear disaster.
The yen and the franc were used to fund such trades until the global financial crisis blew up in September 2008, each returning an average 11 percent per annum, according to Citi. Later, when the US Federal Reserve introduced its ultra-easy monetary policy, the dollar usurped their role. But with the Fed looking increasingly likely to end its quantitative easing programme this June and seeking to normalise monetary policy, the dollar's dominant role in funding carry trades as investors take on more risk may be coming to an end.
"Releveraging should be bearish for the Swiss franc and I think the trend is turning for the currency (to weaken)," said Chris Turner, head of FX strategy at ING. "We're not looking for the SNB to raise rates until Q4. If the Fed does change its stance and starts to normalise policy, the dollar may get an initial 3-5 percent rally," he added. The SNB held its target interest rate at 0.25 percent at its quarterly meeting in March. A weak dollar slipped to record lows against the franc this week but investors believe the SNB will be reluctant to raise rates and push the franc higher for fear of threatening an economic recovery.
MORE LOSSES IN STORE Marcus Hettinger, global FX strategist at Credit Suisse, said the SNB was likely to hold off from raising interest rates for the time being and that this would see the franc come under more pressure, especially against the euro. He sees the euro moving towards a target of 1.3500 francs by year-end. Euro/Swiss currently trades around 1.3020, off a record low of 1.24 hit at the end of December. "Our fair value models using PPP (purchasing power parity), show fair value for the franc against the euro is around 1.40 francs," Hettinger said.
A rate rise from the European Central Bank last week helped to push the spread between two-year euro zone and Swiss rate swap yields out to around 1.7 percent. The spread last reached this level at the beginning of 2009, when euro/Swiss was trading around 1.50 francs. This gives the franc further scope to fall over the course of this year.
Latest IMM speculative positioning data shows those holding Swiss longs in the ascendancy, also suggesting the franc may fall, though longs were halved in the week to April 5. Indeed, currency fund managers are actively shorting the Swiss currency for use in carry trades.
"We are short the Swiss franc but only against the Norwegian crown," said Dennis van den Bosch, senior portfolio manager at Henderson Global Investors, which has 61.6 billion pounds of assets under management. The Norwegian crown's tight correlation with surging oil prices makes it an attractive bet. Norwegian key rates are currently 2 percent, with the Norges Bank attaching a strong possibility that they will need to rise by mid-2011.
SHORT YEN AND FRANC FOR BETTER RETURNS Some analysts say more investors may prefer to sell the Swiss franc once the investment community realises this strategy is generating healthy returns.
"A rapid realisation that carry traders are earning superior returns, with the bulk of those returns coming on the short side of the equation in Swiss franc and yen rather than on the long side of the equation in Aussie and the Norwegian crown, would likely lead to further CHF and JPY weakening in the weeks ahead," Citi said in a note.
With the nuclear crisis in Japan still far from resolved, there is a lingering threat that large repatriation flows by Japanese investors could throw a spanner into yen-funded carry trades. In that scenario, investors' use of the franc as the main funding currency may increase. "If events in Japan continue to worsen and become a key focus for risk, this increases chances of the Swiss franc being used to fund carry trades instead of the yen," said Chris Walker currency strategist at UBS.