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EUR/CHF Parity: Was the Once Unthinkable on the Horizon?

By , Currency Analyst
08 August 2011 21:52 GMT

The past few years have been quite the ride for the EUR/CHF pair, which was trading as high as 1.6828 in October 2007, before the drastic global shift to risk-aversion amid the start of the financial crisis that consumed the world’s most advanced economies.The Swiss Franc has appreciated almost 56 percent against the Euro since October 2007, with approximately 17 percent of those gains coming in 2011 alone – gains once deemed unthinkable considering the burgeoning economic might of the European Union.

Euro-Franc Weekly Chart: May 2007to Present

EURCHF_Parity_Was_the_Once_Unthinkable_on_the_Horizon_body_Picture_1.png, EUR/CHF Parity: Was the Once Unthinkable on the Horizon?

Charts created using Strategy Trader– Prepared by Christopher Vecchio

Given the recent appreciation by the Franc, not just against the Euro but across all major currencies, the EUR/CHF pair is on the verge of parity, or an even 1.0000 exchange rate. The EUR/CHF pair is currently trading around 1.07, roughly 900-pips down from July 26, the last day the pair traded above 1.16. Are another 700-pips lower out of the question? I would think not: if the pair was able to depreciate by 7.76 percent on perceived market uncertainty, what’s to stop an even quicker 6.54 percent depreciation to EUR/CHF pair parity now that all the cards are on the table? As investors flee to the Franc as a safe haven, many concerns have arisen about the implications of the currency rising too quickly, despite the short- and medium-term fundamental backdrop that suggests the currency has yet to peak against the Euro.

The Swiss Franc, already one of the world’s lowest yielding currencies, was undercut by the Swiss National Bank on August 3, when the central bank lowered its key benchmark rate to “as close to zero as possible,” while simultaneously increasing the supply of Francs to the market. On August 5, Swiss National Bank President Philip Hildebrand stated that policymakers are “willing to take further measures if those are necessary” in order to weaken the Swiss Franc. He further stated, “At some point, an overvaluation becomes absurd and that is already the case the Swiss Franc today.”

Acting as if market participants found the rhetoric to be merely smoke-and-mirrors, the Swiss government announced on August 8 that it found the Franc “massively overvalued,” and the resilient currency would harm growth in the coming quarters: one reason the Swiss National Bank cut rates in order to weaken the currency was the concern that the Franc’s “strength [has been and is] threatening the development of the economy and increasing downside risks to price stability in Switzerland.Or, in other terms: exports will be hurt and overseas sales at companies will be affected as well; Swiss companies will lose their competitive edge if the currency continues to strengthen.

Euro-Franc Hourly Chart: August 1 to Present

EURCHF_Parity_Was_the_Once_Unthinkable_on_the_Horizon_body_Picture_4.png, EUR/CHF Parity: Was the Once Unthinkable on the Horizon?

Charts created using Strategy Trader– Prepared by Christopher Vecchio

Despite such posturing by the Swiss government and the country’s central bank, the EUR/CHF pair touched an all-time low of 1.0620 on August 8. While the Japanese Yen and the U.S. Dollar have long been considered traditional safe haven currencies (and those assets denominated by Yen or Dollars), the economic and political troubles facing both countries have diminished their attractiveness as safe havens in times of global uncertainty. In fact, it is interesting to note that both the Dollar and the Yen have found support in recent weeks, though the Franc’s considerable strength against the more traditional safe havens suggests that the paradigm is shifting.

The most recent wave of Franc strength comes on the heels of a massive global equity sell-off leading up to and ensuing Standard and Poor’s downgrade of the United States’ government debt. The results have been disconcerting, to say the least: there has been a greater-than 10 percent decline in most American and European equity markets since August 1; Gold, another traditional safe haven, has climbed above $1700/oz; and the EUR/CHF and USD/CHF pairs have traded near 1.0700 and 0.7600, respectively.

Spanish-German 10-year Government Bond Spread: January 2011 to Present

EURCHF_Parity_Was_the_Once_Unthinkable_on_the_Horizon_body_Picture_10.png, EUR/CHF Parity: Was the Once Unthinkable on the Horizon?

Courtesy: Bloomberg

As markets adjust to a new financial landscape in which the long-term prospects of the U.S. Dollar (and accordingly, Dollar denominated assets) are dimming, further pressures persist in Europe that suggest the necessity for an alternate safe haven is likely to exist for an indefinite period of time. The European Troika – the European Commission, the European Central Bank and the International Monetary Fund – were evidently convinced that a second Greek bailout package would remove any market uncertainty, though now it is clear that the half-life of such a confidence booster was merely three weeks as concerns spilled over larger periphery nations. The contagion issues facing Italy and Spain are not quick fixes, this is clear. Although agreements and proposals are being developed to reduce debt levels in these countries, the dangers that the high debt levels pose will linger in the Euro-zone for some time.

As such, the Swiss Franc is likely to continue its appreciation, especially considering the fundamental backdrop of a fracturing Europe. The safe haven’s attractiveness is backed by the strong growth prospects for the peaceful, landlocked European nation.Unemployment in the country is low at only 3 percent,and, even more reassuring to investors, is Switzerland’s current account surplus. Furthermore, the Swiss economy is expected to grow by 2.1 percent this year, which is much higher than the advanced economies on either side of the Atlantic Ocean, both of which are responsible for the mess the global economy finds itself in. The USD/CHF pair could find some support in the near-term now that it’s clear that markets are in the midst of an acute bear run, as the cloudiness surrounding the United States’ creditworthiness has been cleared for the time being. However, as the European Central Bank, now seemingly at their wit’s end after enacting bond purchases to mop up Italian and Spanish bonds, runs out of policy tools to prevent a catastrophic meltdown in Europe, investors seeking haven will continue to pour into Switzerland’s currency, pushing the EUR/CHF pair to parity and perhaps below, regardless of what the Swiss National Bank does – that is, everything short of fixing the Franc’s exchange rate above parity.

Written by Christopher Vecchio, Currency Analyst

To contact the author of this report, please send inquiries to: cvecchio@dailyfx.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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08 August 2011 21:52 GMT