An Exchange Rate Not to Be Forgotton


IMPORTANT INDICATOR - One of the markets out there that I believe has the ability to offer a lot more insight than many might think is EURCHF. We all remember this market in January 2015 and if you don't, it's probably a good thing. But since the January 2015 historic collapse in this rate, the market has moved into stabilization mode, consolidating more than anything else. But if we are to truly zoom in on the price action over the past several months, this market has been trending to the downside, albeit at a snail's pace. And yet, the downside price action could be telling us a lot! To understand this market is to understand global risk flow and Swiss central bank  (SNB) policy. 

WHY? - Traditionally, the Swiss Franc is treated as a safe haven currency. Due to Switzerland neutrality, favorable banking laws and massive reserves, the Swiss economy is attractive as a flight to to safety destination when the world becomes a less certain place and investors want to run to secure their assets. In these environments, investors are not concerned with yield and only concerned that their assets are protected. And so, investors will convert their investments from whatever currency they are in and move them into Swiss Francs. As you can imagine, this type of investor reaction has the logical effect of forcing an appreciation in the Swiss Franc. So in the case of the EURCHF rate, the market moves lower. 

STRATEGY - However, the big story with the SNB is that the Swiss Franc has appreciated far too much in recent years and is exceptionally overvalued. To offset this demand for the Franc, the SNB has intervened to weaken the Franc while also going to negative rates. So if you want to ensure your money is safe, you put it in Francs and have to pay to store it there. Between the intervention and negative rates, one would think the Franc would fall off a cliff as per what the SNB wants. But that hasn't happened. What's even more distressing for the central bank is the fact that global equities have been making a record run, something that should fuel risk investment in FX, influencing a lower Franc. But even with all the stock market gains, the Franc has barely budged.

The Swiss Franc is a currency that many overlook these days, but that could be a mistake. Via @joelkruger

TROUBLE? - So what does this tell us? In my view, it tells us there is a lot more worry out there than the equity markets would have us believe and the SNB is fighting a very tough battle that could get a lot tougher if global equities actually falter. Again, if the Franc should weaken in times of risk on, the fact that it hasn't weakened in this stock market rally suggests the currency market is worried about something. Seemingly, the SNB has been quite active supporting the EURCHF rate on dips in the 1.0600s but has been unsuccessful influencing sustained EURCHF gains. And if the stock market drops off hard, the SNB will be needing to fight against a lot more global demand for Swiss Francs that will ultimately prove to be a challenge even too big for the SNB. So two takeaways from this update. 1) The fact that EURCHF hasn't rallied with stocks up warns of distress. 2) If this distress manifests via an equity market meltdown, we could see another massive appreciation in the Franc and drop in EURCHF. 

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