By Alun John and Dhara Ranasinghe
LONDON, Aug 19 (Reuters) – A weaker Swiss franc could be an unexpected consequence of recent rare U.S.-Japanese intervention to prop up the yen, bringing relief to companies and policymakers in Switzerland who have grappled with the strength of their local currency for years.
The franc is still 12% stronger against the euro than five years ago, despite some recent softening, thanks to Switzerland’s persistent current account surplus, sound public finances, low inflation and safe-haven inflows. Its strength has made the country’s exports more expensive and squeezed economic growth.
Both the yen and the franc are influenced by the FX carry trade and weaken when investors borrow in these currencies with low interest rates to sell them and buy higher yielding assets elsewhere, often emerging markets.
The yen has long been the funding currency of choice but it is expected to remain jumpy with traders alert to further intervention risk. That has prompted the start of a rotation to the Swiss franc, say analysts and investors, a trend that will likely continue if Washington and Tokyo are able to engineer a stronger Japanese currency.
“Market participants will be thinking about rotating some of their funding positions,” said Fredrik Repton, senior portfolio manager with the global fixed income and currency management teams at Neuberger Berman.
“If you look at the performance of euro-Swiss, that’s probably more instructive to how the market environment has been shaping up.”
At around 0.9385, the franc is near its weakest in around a year against the euro, having softened about 4% from March’s 11-year peak near 0.9. It is also down nearly 7% from an 11-year high hit versus the dollar in January.
Rabobank last week revised up its 9- to 12-month target for euro/Swiss franc to 0.95 from 0.94, reflecting expectations the franc will weaken further.
THE FX CARRY TRADE IS CHANGING
Carry trades are having their best run in years, boosted by low FX volatility. But they become more challenging when a currency starts to swing, wiping out the small profit from rate differentials.
Analysts say it is hard to pin down the size of the carry trade, but point to currency short positions, essentially bets on an asset weakening, as a good proxy.
The recent intervention has prompted an unwinding of yen short positions, pushing the outstanding number closer to those in the franc.
“It’s going to take a lot to shift away from the yen as a funding currency, but there is a lot out there to shake people out of that habit,” said ING’s global head of markets Chris Turner.
