chf fundamentals

2007 Second Quarter FX Outlook

Tuesday, 10 April 2007 21:53:08 GMT  |  Daily FX Research Team

USD/CHF Outlook
It has been a great time to be long Swiss francs as the underlying currency has strengthened by 4.3 percent against the US dollar in the first quarter.  This decline equated to a little over 500 pips as the currency pair dropped from 1.2550 in January to a low of 1.2075 in March.

The strong rise has been driven by reports of continued growth in the Swiss economy. as improvements were seen in both exports  and domestic consumer spending.  The recent spate of growth has kept the Swiss National Bank, and its chairman steadfastly hawkish, adding to speculation of further rate hikes in the near future.  However the currency’s carry candidacy continues to weigh in on the spot price’s performance against higher yielding currencies like the British pound and euro, which have gained considerably against the franc during the first quarter.  As a result, the tug of war between the Swiss National bank’s conservative pace of tightening and the demand for carry could continue to overshadow the country’s strong economic performance going into the second quarter.

Consumer Spending Drives Growth
Global demand continues to clamor for Swiss made goods, as exports rise and economic growth accelerates in the first three months of the year.  Industrial production activity was particularly strong, jumping by 8.9 percent yoy as the demand drives the expansion in the manufacturing sector.  For the year so far, the sector has performed above the 61 figure average seen in the first quarter of last year, according to recent manufacturing surveys.  This particular  rate of expansion has fed positively into the labor force as companies ramp up hiring in order to meet production levels.  As a result,  labor force additions have kept the national employment rate at a record low, just above 3 percent.  With confidence on the consumer level the highest in six years incidentally, there is no wonder why retail sales growth has accelerated above and beyond forecasts.  With more income, consumers are also more wiling to spend freely. According to the most recent figure released by the Federal Statistics Office, Swiss retail sales advanced strongly for the eighth consecutive month.  Leading indicators also increased for the second straight month in March, which suggests that GDP growth will continue to remain above an annualized pace of 2 percent in Q2.  .  As a result, contributions from both consumers and manufacturing growth will boost rather low rates of inflation.  This will provide for ample evidence in supporting another move by Chairman Roth and fellow monetary members in hiking rates in their quarterly assessment scheduled for June 14th.  Already raising rates six full times since the end of 2005, the central bank has increased short term borrowing costs to 2.25 percent and will likely remain hawkish amid consumer prices rising less than 1 percent.  The theme will help keep the Swiss strong against the US dollar as sentiment leans towards a probable rate cut by the US Fed later on in the year.   However, as everyone knows, everything that goes up must come down, economic growth is no different.  Looking ahead, there are no major risks to Swiss economic growth but nonetheless the pace of expansion will most likely slow.  With that adage, traders will be wary of any weakness that may creep up in the second quarter as manufacturing, and subsequent consumption, is due for a mid term pullback.  Should signs of an economic soft patch emerge, fundamentalists will look past the plausible rate stay in June, and instead towards the a possible hike in September 13th. 

Rates Will Be Hiked Along With ECB
Having just raised rates by 25bp in March, the central bank remains hawkish but this could change if data begins to sour.  The SNB has been raising interest rates in lockstep with the ECB, albeit on a somewhat delayed basis since the central bank only has monetary policy meetings quarterly. Each dose of tightening also slows the economy, which the SNB has to be particularly careful of. Chairman Roth shares ECB President Trichet’s same enthusiasm to quell acceleration in price increases and there is a greater deal of evidence to purport such a move by Swiss policy makers.  As mentioned before, the export sector remains supported by stabilized global demand, while consumer spending continues to bolster higher prices.  However, the question remains: what happens when both factors begin to slowdown?  Although remaining relatively supported, the Swiss economy is beginning to show some signs of weakness in the near term.  For the month of February, exports actually fell 3.2 percent on a seasonally adjusted basis.  The decline reversed export growth of 1.4 percent in the month of January according to the Federal Customs Office.  In addition, dampening stronger inflationary suggestions, core consumer prices are inching higher, rather than reflecting a growing economy.  Instead, consumer prices are tepidly hovering around 1 percent, hardly enough to be considered inflationary.  This handful of reasons may be evidence enough to compel monetary authorities in breaking with the overall Euro zone bias, venturing to leave rates on hold and keep Swiss interest rates on the low end of the G7 scale until the second half of the year.

Carry Trade Continuance
Fundamentals however have not been the primary driver of Swiss strength or weakness in the past few months.  Instead, demand for carry trades has dictated the currency’s price action.  With interest rates at 2.25 percent, the Swiss franc is still considered one of the world’s lowest yielding currencies.  This characteristic was exactly what drove EUR/CHF to the highest level since the introduction of the Euro in the beginning of the second quarter.  Similar to the Japanese yen carry theme, as long as the world remains in risk seeking mode, traders will continue to use low yielding currencies in order to fund higher yielding investments.  Nothing can be truer than the comparison against the British pound.  With British policy makers still likely to increase interest rates twice by year end, according to future contracts pricings, the considerable carry advantage will be maintained.  Already at 5.25 percent, the UK interest rate is expected to rise to a whopping 5.75 percent.  When paired against interest rates of 2.25 percent in Switzerland, the carry advantage remains at 350 basis points.  As long as the ECB and BoE continue to consider raising rates, the Swissie could under perform against those currencies. 

Conclusion
Ultimately, Swiss enthusiasts will likely be in for a long three months in the second quarter, as fundamentals factors continue to battle countering capital flows in establishing a directional bias.  So long as consumers and exports continue to support economic growth in the near term, potential bursts in inflation will remain on the minds of hawkish central bankers.  For that matter, further interest rate hike speculation will be on the minds of traders.  But countering forces on the carry notion may jeopardize the theme and keep EUR/CHF and USD/CHF moving in different directions.  Nonetheless, one thing remains certain which is that interest rates continue to reign over market focus.  As a result, currency players will be keeping an eye out for the next quarterly interest rate statement by the SNB.  Should SNB Chairman Roth decide to break from the mold, it may be the beginning of a new trend for the second half of the year.

Technical USD/CHF Outlook
The USDCHF decline from the November 2005 high (1.3285) to the December 2006 low (1.1877) lasted 56 weeks, one week shy of the key Fibonacci time frame of 55 weeks.  The 1.1286-1.3285 rally that preceded this decline lasted 47 weeks.  More time (55 weeks compared to 47 weeks) and less price distance is corrective.  Also, lows in May 2006, December 2006 and March have held near the 61.8% retracement level of 1.1286-1.3285 (1.2050) and created a triple bottom in the process.  Barring a break below 1.1877, the USDCHF should work higher in a C wave.  The initial objective is 1.2721, which is where the rally from 1.2027 would equal the 1.1877-1.2569 rally.  However, if the larger bullish count is correct, then the pair should rally above 1.3285 in the next 50 weeks or so.   

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