Franc Truce Threatened as Ukraine Tension Escalates

Any escalation of the Crimean crisis risks shattering a 17-month truce between currency traders and the Swiss National Bank as demand for haven assets pushes bets on a weaker franc into retreat.

Switzerland’s currency came closer to its 1.2 francs per euro cap than at any time in the past year yesterday as tension between Ukraine and Russia over the southern region of Crimea deepened yesterday. Options traders were the least bearish on the franc since May, and the currency’s appreciation is defying analyst calls for it to drop.

“There’s no recycling of francs overseas and, given the state of risk appetite, there’s no reason to go overseas at this point,” said Geoffrey Yu, a currency strategist at UBS AG in London. “A lot will depend on how the Ukraine situation develops. Downside inflation pressures are still strong and the SNB will defend the floor as much as possible.”

The franc’s strength is a scourge for SNB President Thomas Jordan, who’s sticking with the exchange-rate cap to keep consumer prices from falling amid a slower economy. Switzerland’s plight is mirrored in Japan, where the yen’s haven status has made it this year’s best performer of 10 developed-nation currencies, denting Prime Minister Shinzo Abe’s attempts to boost growth via unprecedented monetary easing.

Putin Speaks

The franc climbed to a 14-month high of 1.2104 per euro yesterday, before weakening today as Russian President Vladimir Putin stepped back from escalating the crisis.

In his first public remarks since Ukraine President Viktor Yanukovych’s ouster last month, Putin told reporters today that Russia isn’t considering annexing Crimea, and argued against Western powers imposing sanctions on his country.

The franc dropped 0.5 percent to 1.2184 per euro as of 12:22 p.m. in New York, snapping three days of gains. The Swiss currency remains stronger than its average over the past year of 1.2301 per euro.

Bets that the franc will strengthen continue to build, and investors should use declines versus the dollar to buy the Swiss currency, Ian Stannard, the head of European foreign-exchange strategy at Morgan Stanley in London, said today in a note.

Franc Cap

The SNB set a cap on its currency of 1.20 per euro in September 2011 after the franc soared to 1.0073, citing the risk of deflation and recession. While Jordan said as recently as January that the currency ceiling will remain in place for the foreseeable future, he also said in December the institution hadn’t intervened to protect it since September 2012.

SNB spokesman Walter Meier declined to comment yesterday about a report by the website Cash that it intervened to push the franc lower via its branch in Singapore.

“The SNB may be under pressure,” John Hardy, the head of foreign-exchange strategy at Saxo Bank A/S in Copenhagen, said yesterday. “Euro-Swiss could be challenged because of real movement of capital. Ukraine is a safe-haven threat because the fallout for Europe if this escalates is very significant.”

The franc has appreciated 0.7 percent this year, based on Bloomberg Correlation Weighted Indexes, making it the fourth-best performer behind the yen, which has gained 3.3 percent, New Zealand’s dollar, which has climbed 2.2 percent, and the Norwegian krone, with a 1 percent gain. The U.S. dollar has fallen 0.1 percent.

Beating Forecast

The franc is already ahead of the mid-year forecast of 1.24 per euro, according to the median of more than 40 strategist estimates compiled by Bloomberg. The currency was overvalued by 11.9 percent in January, according to a gauge of its effective strength in real terms versus 40 trading partners, published in the SNB’s monthly statistical bulletin.

Switzerland’s gross domestic product rose 0.2 percent in the three months through December from the previous quarter, the State Secretariat for Economic Affairs in Bern said in a Feb. 27 statement. That missed the 0.4 percent median estimate in a Bloomberg survey of 18 economists.

A report this week will show Swiss consumer prices, calculated using a harmonized European Union method, rose 0.3 percent last month from a year ago, according to the median estimate of analysts in a Bloomberg News survey. The highest rate since the SNB introduced the cap is 0.5 percent, reached in July last year.

‘Severely Curtailed’

The SNB’s cap on the franc remains essential to guarantee adequate monetary conditions even if the euro area’s debt crisis has eased, board member Fritz Zurbruegg told Switzerland’s Le Temps newspaper two weeks ago.

“We say in fact the minimum exchange rate remains as long as necessary,” Jordan said in Davos, Switzerland, on Jan. 24. “We have to ensure adequate monetary conditions. For the time being, this is the minimum exchange rate.”

Investors may be more inclined to bet on the yen strengthening than the franc because of the SNB’s resolve to defend its currency, according to Daragh Maher, a foreign-exchange strategist at HSBC Holdings Plc in London.

“There is a natural hunt on for safe havens given the uncertainty over Ukraine, but the ability of the CHF to play this role is severely curtailed by the proximity of the floor,” said Maher. “So if you want to be protected against an escalation of tensions, you have more room for gains being long the yen than you do being long the franc.”

Kerry’s Visit

U.S. Secretary of State John Kerry headed to Kiev after the leaders of the Group of Seven nations condemned Russia’s actions as a clear violation of Ukraine’s territorial integrity. While Putin ordered soldiers in western Russia to return to their bases as military exercises ended on schedule today, the Kremlin continues to have 16,000 troops deployed in Crimea.

Options traders are backing away from bets on a weaker Swiss currency.

The premium for options betting on the franc falling versus the euro in 12 months, versus equivalent bets on an advance, has narrowed. The one-year 25-delta risk-reversal rate reached 0.28 percentage point yesterday, the lowest since May 2013, and was at 0.34 percentage point today.

The SNB’s foreign reserves holdings stood at 437.7 billion Swiss francs ($495 billion) in January, compared with 435.2 billion francs in December, data on its website showed Feb 7. Economists had expected them to remain steady at 435.8 billion francs, according to the median of five estimates.

The dollar and the yen will likely be the beneficiaries if SNB defends its cap of 1.20 per euro, said Clement Miller, a Baltimore-based investment strategist at Wilmington Trust Investment Advisors, which manages $79 billion.

“They have the resources to defend the 1.20,” Miller said by phone. “It’s just a question of how much in resources are required to do that. It’s a question of how serious and how protracted this whole crisis becomes.”

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