EUR/CHF: A big vote of confidence in the recovery

In terms of characteristics, the CHF certainly sits in the bucket of low-yield defensive currencies, similar to the JPY.

The Swiss central bank policy rates have been deeply negative (at -0.75%) ever since the Bank abandoned the 1.20 EUR/CHF floor in 2015. Despite this deeply negative rate, EUR/CHF has largely stayed under pressure since March 2018 – when Donald Trump fired the opening shots of the trade war.

Lows were made near 1.05 in April 2020 at the height of pandemic pessimism. The SNB has been trying to resist CHF strength with FX intervention – arguably the only marginal tool left in the central bank’s monetary toolkit. Indeed, the massive FX intervention undertaken by the Bank last year (FX reserves grew CHF130bn last year) prompted the US Treasury to label Switzerland a currency manipulator.

However, everything has changed this year. As confidence is growing in the global recovery (inflation, not growth fears are now dominating), we suspect investors are re-assessing their need to hold precautionary CHF long positions.

One chart that has driven our thinking on the CHF has been the amount of precautionary capital sitting in the CHF

One chart that has driven our thinking on the CHF has been the amount of precautionary capital sitting in the CHF. Trying to gauge this is a difficult task, but we think BIS data on reporting banks' liabilities by currency is a good starting point. Here all BIS reporting banks every quarter report on their stock of liabilities by currency, where those liabilities are largely deposits.

What we’d like to highlight in the chart below is a) the build-up in CHF deposits that led to a break in the EUR/CHF floor in 2015 and b) the sharp build-up in CHF deposits in 3Q19 at the height of the US-China tit-for-tat trade war (USD/CNY traded close to 7.20 in that window). CHF deposits rose $84bn in that quarter alone and crucially appear to have been retained up until the most recent data in 3Q20.

As trade war and global recession fears recede, we expect further unwinding of those precautionary CHF long positions. Recall that EUR/CHF was trading close to 1.20 before the trade war began in March 2018.

In addition to the positioning data provided by the BIS deposit liability data, the more conventional positioning data provided by the CFTC makes the point that speculators have been running long CHF positions since late 2019 and have only recently started to trim them.

Below we show a long-term graph on EUR/CHF largely to make the point that speculators typically run large net CHF short positions during benign periods for financial markets – most recently in late 2017 and into early 2018. But also in 2005-2007, when a synchronized global recovery drove Brent through $100 (sound familiar?).

And certainly, that’s some of the thinking behind our 1.30 end-year forecast for EUR/USD.