Swiss Franc May Decline as Path Clears for Risk Correction

Broadly speaking, the underlying fundamentals behind the Franc have remained constant: GDP likely contracted for the fourth consecutive quarter in the three months to September and is not expected to return to show even modest positive growth until 2010, while inflation shrank for the eighth straight month in October, keeping the onset long-term deflationary stagnation a ongoing concern. This translates to an SNB that is comfortable at record-low interest rates and is likely to push forward with quantitative easing as well as exchange rate intervention any time EURCHF nears 1.50. On the whole, this has translated into a relatively stable currency; indeed, the volatility of a trade-weighted average of the Franc’s value has fallen to the lowest level in over two years.

Where active trading is likely to materialize, however, is in USDCHF, with the trajectory being set by the markets’ overall appetite for risk. Traders’ seemingly indifferent response to Friday’s Nonfarm Payrolls report, typically a major market mover, seems telling: stocks, gold and the US Dollar Index were little changed, and although crude oil sold off, it did so within the confines of the same $77-80 range that has contained prices in recent weeks. This hints that perhaps markets were looking to get past the last piece of significant event risk (with all major rate decisions and US GDP all out of the way) to begin a meaningful correction of the broad rally in risky assets that has defined capital markets since early March.

Signs of a coming downturn began to emerge in October as the MSCI World Stock Index fell the most in since February while the VIX index of US stock options volatility that is often seen as a proxy for investors’ risk aversion gained the most in a year. The bears attempted to push prices lower several times over recent weeks but have been frustrated by the economic calendar. With big fundamental data now out of the picture for the remainder of November, the coast looks clear for a downswing to gain momentum. Should this materialize, capital will likely find its way back into the safety of the US Dollar, sending USDCHF higher.