The biggest news to hit the currency markets is the recent announcement that the Swiss Franc (CHF) will be pegged to the Euro (EUR). With this policy the Swiss Central Bank has tipped their hand to traders. Here’s why…
The Swiss National Bank has set a limit to the CHF’s strength by adopting an official policy of weakening the currency. The Swiss National Bank even released a formal statement saying it would buy foreign currency in unlimited amounts to keep the CHF at a weaker level.
The move to peg the CHF to the EUR has surprised many traders, but the motivation is clear: Switzerland has to devalue their currency to protect their economy.
Protecting their economy
Switzerland depends on exports as a major part of their economy and the strength of the currency has hurt on many levels. The lower the Swiss currency, the more competitive their goods will be in the world market. In response, Swiss stocks rose on the news of the CHF’s fall.
The Swiss National Bank will not allow the CHF to rise above 0.83 EUR in value, displayed as SFr1.20 to the euro. Intervention on this level is extremely rare and resulted in a 9% drop only 15 minutes after the announcement. Many expert Forex traders agree that it was the single biggest currency move they had ever seen.
After this announcement the SFr did get as low as 1.1020, or even lower than targeted. However the day ended around SFR1.2026, which was closer to the intended target.
A strong CHF earlier in the year hurt exports by making them relatively more expensive. An overly strong Swiss Franc also hurt the tourism industry. Even Swiss consumer spending was affected because Swiss living near the border would go to Germany to do their shopping to spend their stronger Swiss money on relatively cheaper German goods. For Swiss businesses to regain competitiveness, the Swiss National Bank chose to intervene and drop the value of the CHF.
But a major concern is whether this policy can hold up. In the past, government currency interventions have only resulted in temporary success. Rarely have these interventions worked over the long term.
The Swiss National Bank could easily find itself fighting currency speculators to keep the CHF value low. Even after intervention, the Swiss Franc sits at a very strong level compared to historical valuations.
The commitment of the Swiss National Bank to keep the currency at a low level should not be underestimated, though. This direct intervention came only after keeping the interest rates close to zero and making more currency available to the market in hopes greater supply would devalue the CHF. These first two efforts failed miserably because of global demand for the Swiss Franc amidst historic levels of concern surrounding just about every other major currency. With such strong demand, the Swiss Central Bank was left with no other choice but to intervene more directly.
The immediate consequences are clear. Not only did the CHF drop dramatically in value against the EUR but it also dropped 8.4% to the USD as well. But this move is not unprecedented. The Swiss National Bank made similar moves in 1978, and back then they also set a ceiling for the currency and intervened to maintain that ceiling.
The difference now is that the CHF has long been viewed as a safe haven currency. Again, because of the worldwide currency market volatility and record low interest rates, the demand for a safer currency is especially high. This high demand for Swiss Francs will inevitably force the value of the CHF back up…but don’t bet against the devaluation yet.
The smart play
For now, the smart play is to trade WITH the Swiss Central Bank’s weaker CHF policy…
But the longer term CHF play is a different story.
Trading the CHF becomes tricky once currency traders feel the currency is too undervalued. While the country’s national bank will continue to work to keep the value down, the currency markets are even more fluid than they were in 1978. And, as George Soros taught the British Central Bank in 1991, there is only so much market intervention can accomplish when in conflict with global market forces.
In addition to this, economists point out two major reasons this intervention might fail:
- The Swiss National Bank’s weak position when looking at the balance sheet
- The Swiss National Bank requires a strong tolerance for inflation that can fade over time
Even so, don’t make the mistake of thinking the Bank will change their policy any time soon. In terms of the Swiss economy, the Bank has everything to gain from a weaker currency and nothing to lose. The reliance on exports and need for lower prices makes a weak currency a national priority. Until the central bank’s efforts clearly fail, traders would be wise to look for opportunities to trade with the weaker CHF policy instead of against.
Right now the CHF is overvalued against the USD, so buying the USD/CHF at this time is the trade I have placed. I am buying at 0.8851 and selling to exit at 0.9799. I have placed my stop loss at 0.8498.