Franc Traders Test SNB as Crisis Meets Negative Yields

Franc Traders Challenging SNB as Crisis Meets Negative Yields
The franc is a favorite in times of stress because the nation is a financial center and exporter of precision products. Photographer: Valentin Flauraud/Bloomberg

For the first time in seven months, traders are testing the Swiss National Bank’s determination to limit the franc’s strength against the euro as Europe’s resurgent debt crisis drives up demand for safer assets.

The franc breached the central bank’s cap of 1.20 to the euro on April 5, and options show investors are predicting even more appreciation. It jumped 1.1 percent versus nine peers in a basket of currencies in March, the biggest gain since July, and is up 2 percent from a nine-month low on Jan. 11, according to data compiled by Bloomberg.

Demand for Swiss assets is so strong that investors accepted negative yields at an auction of six-month government bills last week as Spain’s borrowing costs rose toward levels that prompted bailouts for Greece, Ireland and Portugal. The franc is climbing against its peers even after the Swiss central bank repeated a commitment to prevent increases that threaten to bring about deflation and hurt exports.

“As long as there is risk aversion tied to rising euro-region stress, investors will want to buy francs,” Peter Frank, a London-based currency strategist at Banco Bilbao Vizcaya Argentaria SA, Spain’s second-largest lender, said in an interview on April 10. “The Swiss franc is an extremely liquid currency, it is tradable throughout all time zones and the economy is very resilient.”

The franc will weaken to at least 1.23 per euro over the next three months as the central bank steps up efforts to counteract its strength, he said.

Estimates Raised

The franc has strengthened against all but one of its 16 most-traded peers in the past three months, according to data compiled by Bloomberg. While gains versus the euro have been limited to 0.5 percent, it surged 8.7 percent against the yen and 3.7 percent versus the dollar.

Switzerland’s currency was little changed at 1.2021 per euro at 3:55 p.m. London time, leaving it 1.1 percent higher this year. It was at 92 centimes per dollar, leaving its advance since the end of December at 2 percent.

Strategists expect policy makers will keep their pledge. Switzerland’s currency will end the year at 1.23 per euro, according to a Bloomberg median survey of analysts. Still, they’re paring estimates for depreciation compared with the Dec. 31 forecast for 1.26 per euro. The franc will fall to 97 centimes per dollar, a separate survey shows, stronger than a prediction of 98 centimes at the end of last year.

‘Very Overvalued’

The “very overvalued” franc may depreciate to 1.35 per euro within a year, as data from Switzerland weakens and as exports suffer, James Kwok, London-based head of currency management at Amundi, the combined investment arm of Credit Agricole SA and Societe Generale SA, which has about $860 billion under management, said in an e-mail on April 12.

A survey of hedge funds and companies by Societe Generale indicated that confidence in the central bank’s ability to hold the cap past June is fading. While responses from more than 6,600 research clients suggested a “very strong vote of support for the SNB,” some investors doubted it would be able to maintain the floor beyond three months, according to Sebastien Galy, a senior currency strategist in New York.

“The feeling is that probably over the next few months they’ll be able to do what they need to do, but the market is becoming far more uncertain,” Galy said in a telephone interview on April 10. “Unless the SNB intervenes to push away euro-Swiss from current levels, these fears will remain.”

Societe Generale raised its year-end estimate for the franc against the euro to 1.23 from 1.30 in December.

Negative Yields

The franc is a favorite in times of stress because the nation is a financial center and exporter of precision products. The country’s current-account surplus, the broadest measure of trade, is equivalent to more than 10 percent of gross domestic product, so it doesn’t need outside cash to fund spending. Since 1975, only the franc and the yen have increased in value, according to Bloomberg Correlation-Weighted Indexes, which track 10 developed-country currencies.

Investors are piling into Swiss assets even though its bond yields are among the lowest in the world. The 10-year security yields about 1.15 percentage points less on average than comparable securities in the U.S., U.K. and Germany.

Six-month Swiss bills sold at an average rate of minus 0.251 percent on April 10, the same day Bank of Spain Governor Miguel Angel Fernandez Ordonez said his country’s banks may need additional capital if the economy worsens “more than expected.” Switzerland’s sale of 2021 bonds on April 11 attracted bids equivalent to 3.92 times the amount offered, up from 2.55 times at a sale a year ago.

‘Safety Is Paramount’

The economy will expand 0.4 percent this year and 1.8 percent in 2013, according to Bloomberg surveys of economists, compared with contraction of 0.4 percent followed by 1.05 percent growth in the euro region. Germany, which buys about 20 percent of Switzerland’s exports, may grow 0.7 percent this year, even as euro members from Greece to Italy shrink.

“The underlying dynamics in Switzerland, in any way you look at it, are still very strong in relation to Europe,” Peter Rosenstreich, chief foreign-exchange strategist at Swissquote Bank SA in Geneva, which has about $8 billion in assets, said in a telephone interview on April 11. “Safety is paramount in this game right now. It’s not about yield seeking, it’s about safety and the Swiss franc plays very well into that.”

The franc will stay “stuck” at about 1.2015 over the next six months, he said.

Too Strong

Swiss officials say the currency is too strong. Even as the SNB has limited gains versus the euro to about 0.4 percent since introducing its cap, after about a 7 percent rise in the previous six months, the franc is 36 percent overvalued, based on an index by the Organization for Economic Cooperation and Development using relative costs of goods and services. Against the dollar, the difference is 39 percent.

“Fact is that the franc’s purchasing-power parity versus the euro is higher, it’s at 1.35, 1.40,” Economy Minister Johann Schneider-Ammann said on March 26. “I’d generally like if the exchange rate was around that level.”

The franc’s advance has lowered costs of imported goods. Consumer prices dropped for a sixth month in March, declining 1 percent from a year ago, after falling 0.9 percent in February, data showed on April 5.

Roche Holding AG, the world’s biggest maker of cancer drugs, said on April 12 that first-quarter sales declined 1 percent. Revenue was hurt by pricing pressure as currency strength cut 3 percentage points off sales growth, the Basel-based company said.

SNB Leaderless

Former SNB President Philipp Hildebrand introduced the cap after the franc rose to a record 1.00749 on Aug. 9.

The Zurich-based SNB has been leaderless since Hildebrand was forced to quit on Jan. 9 over a purchase of dollars by his wife in August, about a month before policy makers imposed the ceiling. The Swiss currency plunged more than 8 percent versus the greenback and the euro on the day the cap was introduced.

Interim SNB head Thomas Jordan said on April 10 at a press briefing in Zurich that doubts about the central bank’s resolve are misplaced.

“The SNB has successfully enforced the minimum exchange rate and will continue to do so, without any restrictions,” Jordan said.

That determination is being tested after Spain’s 10-year yield reached 6 percent for the first time since December last week. Spain’s $1.4 trillion economy is about twice the combined size of the three euro-region nations that received aid from the European Union and International Monetary Fund.

‘Pressure the Franc’

“Spain will probably have to have an EU/IMF program,” Dale Thomas, head of currency management in London at Insight Investment Management Ltd., which oversees about $267 billion in assets, said in a telephone interview on April 11. “It’s very hard to see flows do anything other than pressure the franc.”

Traders are betting the currency will gain versus the euro over the next three months, a reversal from predictions for a decline made between March 14 and April 3.

The premium for three-month options granting the right to buy the franc against the euro relative to those allowing for sales was at 1.92 percentage points April 11. On March 28, the so-called 25-delta risk-reversal rate was at 0.26 percentage point in favor of options to sell the currency, the most bearish reading since May 2006, based on closing levels.

“There is a clear risk to the euro, so people still prefer the franc in case the worst happens,” Yves Longchamp, a Geneva-based currency strategist at Pictet & Cie, which manages the equivalent of $270 billion, said in an interview on April 12. “On the one hand you have a good economy performing well, and on the other hand you have doubts about Europe, so the Swiss franc will remain expensive.”

(Removes reference to franc breaching euro cap a second time in second paragraph.)
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