The Swiss franc is forecast higher against the euro and British pound as it enjoys the benefits of one-time inflows, ECB policy easing and hedging demand ahead of the UK's referendum on EU membership.
- "We have changed to a less bearish stance on CHF, seeing a bottom in EUR/CHF of 1.05 by 2Q16" - Morgan Stanley
- Massive M&A flows to favour Swiss franc argue JP Morgan.
- HSBC recommend buying the franc as a hedge on Brexit stresses
- Interest rate decision due today
Ahead of Thursday's Swiss National Bank Decision we hear the outlook for the franc has improved notably.
If, as expected, the SNB opt to sit on the sidelines, the pro-CHF bias held by some leading analysts will only be strengthened.
Since the last SNB meeting growth has picked up faster than expected, sentiment has improved and inflation risen. The franc is back to levels seen in December though and it would appear the prospect of direct currency intervention is all that stands in the way of a firm currency.
The Swiss franc has outperformed of late even as markets turn risk-on; typically this safe-haven currency sheds weight when markets and commodities rally, as they have been recently.
So what is behind the outperformance and what does it tell us about the outlook for CHF going forward?
JP Morgan's Paul Meggyesi has assessed the lie of the land now we are a couple of months into 2016 and gives three reasons why he is more bullish on CHF in the year ahead.
1) Easing at the European Central Bank, the easing announced by Draghi & Co. should ‘out-ease’ the efforts of the Swiss National Bank.
2) Capital inflows which together could boost CHF demand by 11% of GDP.
There are two sources of inflow support notes Meggyesi. A large outstanding M&A inflow which at 6% of GDP would offset the entire net M&A outflow from last year.
That transaction is scheduled to complete in April subject to regulatory approval and it is possible that investors might wish to hedge their FX exposure ahead of that date.
Secondly there is the potential for Poland to implement a mortgage conversion plan – outstanding CHF mortgages in the country amount to CHF 34bn, or 5% of Swiss GDP.
3) Brexit hedging demand. “Brexit anxiety is likely to be spilling over to CHF as the franc hedges not only the risk of a sharp GBP depreciation in the event of a Brexit, but also the potential collateral damage to the euro and risk markets more generally under such a scenario,” says Meggyesi.
The Hedge in Action, as Recommended by HSBC
If you need proof as to how the Swiss franc will be used to hedge Brexit risks, look no further than the strategy team at HSBC.
HSBC’s global head of research, David Bloom, has recommended going long the Swiss franc as the ideal hedge in case of the sterling weakening following a Brexit vote.
According Bloom the pound is at risk of falling 15-20% in the event of the UK voting to leave the EU.
Those with an exposure to the pound, however, could hedge against this potential decline by buying Swiss Francs.
Bloom argues the Franc makes the perfect instrument for hedging against a depreciation in the pound, because of its “asymmetrical” nature.
By this he means that although it is likely to rally if the UK leaves the EU due to its safe-haven status, it is unlikely to fall markedly if the UK should vote to remain within the EU.
The alternative of selling sterling as a hedge has massive downside risk:
“Being long the CHF may be the best hedge against "Brexit". It might be tempting to sell GBP as a hedge, but the problem is that if "Brexit" were rejected, GBP would rally strongly, making the hedge a potentially expensive exposure.”
The beauty of opting for the Franc is that is has little downside risk, with the main risk coming from its rapid appreciation attracting the attention of the Swiss National Bank, who might intervene to devalue the currency, however, Bloom sees this as unlikely to impact much:
“The SNB may intervene, but we believe it would only, at best, be able to slow the move rather than reverse it. However, were "Brexit" rejected, we would not expect maintenance of the status quo to provoke much CHF weakness.”
Swiss Franc Bearishness on Hold
It would seem consensus in the institutional community is certainly establishing itself around a firm CHF going through 2016.
"We have changed to a less bearish stance on CHF, seeing a bottom in EUR/CHF of 1.05 by 2Q16, and we now target 1.07 by year-end. We expect CHF to rally in times of risk-off but not as much as JPY," say Morgan Stanley in their latest FX forecast piece entitled "Spring Global FX Outlook."
Analysts expect CHF to rally particularly against EUR, when the risk-off sentiment is generated from within the eurozone and not from elsewhere in the world.
The repatriation flow of euro area assets back to Switzerland will overwhelm the currency in times of euro area stress.
"This year such stress could be generated from higher probabilities of Brexit; negative interest rates hurting the already low profitability and thus funding position of eurozone banks; and any signs that the stresses from immigration in Europe are getting worse," say Morgan Stanley.