Tuesday, June 23, 2009

Why the Swiss Are Desperate to Force the Franc Lower

By Sean Hyman Right now, the Swiss are desperate to push their currency lower – especially versus the euro. Let me explain why…

Swiss exporters are getting clobbered by the strong franc this year. A ton of Switzerland’s exports are shipped throughout Europe, so the Swiss have to worry about the EUR/CHF exchange rate, even more so than the USD/CHF exchange rate.

Swiss exports have fallen 17% in the past year. Ouch!

The only thing the Swiss can do to stop it is sell francs like crazy and keep their interest rates exceptionally low. They have to push interest rates lower enough so investors have no desire to buy francs vs. other currencies, particularly the euro.

The Point of Desperation for the Franc

When the exchange rate with the euro dropped below 1.45, the Swiss National Bank cried “uncle.” They simply couldn’t afford to let their exporters suffer anymore. If that trend continued it could put many of the exporters out of business and skyrocket the nation’s unemployment.

The Swiss National Bank has said before that they draw the line when the EUR/CHF exchange rate reaches the 1.50 level. They want the exchange rate to stay at that level or they’ll intervene in the market.

Swiss National Bank draws a line in the sand around 1.50
on the EUR/CHF exchange rate!

Indeed, the Swiss National Bank has already done that several times over the past couple of months. That’s what stopped the exchange rate from falling notably below 1.50.

Can it drop below that? Sure! However, if it does, you can bet the Swiss central bank will sell an unlimited amount of francs to get the desired result over time. In fact, Chairman Roth explicitly said that, “keeping a lid on the franc is a key element of policy.”

This means the Swiss National Bank will keep rates near zero percent (0.25%). They will also be very quick to pump large amounts of francs into the market and water down the franc. They can sell francs and buy euros all day long if they need to.

At this point, they don’t have to worry much about inflationary effects as they do deflationary effects. Yes, the central bank is saying that their inflation rate may be near zero on into 2011.

You Can Support the EUR/CHF and Win Too

Knowing this, if you have a longer-term view, you can join the Swiss National Bank by buying the EUR/CHF pair. You’ll earn some daily interest while you wait on the position to appreciate.

It won’t be a fast gainer for a bit, but it likely won’t have a fast drop well below 1.50 anytime soon either. If it does, you can count on the central bank to do their best to come to your aid and support the EUR/CHF pair.

I do caution short-term traders usually can’t benefit from these types of actions because the central bank doesn’t always get their wishes in the short- term. However, if you look back historically, over the medium to longer- term, they usually do get their mission accomplished. This likely won’t be an exception either.

Besides that…if we were to have a “double dip recession” and higher yielders started to fall once again, this one might fall the least just because the central bank is behind your trade. Stay on the side that has the most “fire power” long- term and you’ll likely be glad you did.