The currency markets have been wild in recent months. Many know about the epic moves in the Turkish Lira and the Russian Ruble. However, even ‘strong’ western currencies have been moving with the volatility similar to cryptos. Take the Japanese Yen now seeing lows not seen since 1998! Many other Asian currencies are taking a hit including the Thai Baht, the Indian Rupee (the weakest it has ever been!), the Korean Won just to name a few.
Followers of my work know I obsess with the US Dollar (DXY). I believe this chart will be one of the most important to follow in the coming weeks to months. In basic terms, the Dollar has the potential to get very strong due to its safe haven/reserve currency status. I know some contrarians talk about the “death of the dollar”, but the truth is the US Dollar is the cleanest clothing item in the pile of dirty laundry. It has problems, but reserve currency status will see the Dollar have a big run as fear and uncertainty rise. Or as some say, the worse things get, the stronger the Dollar will become.
Some of this may sound familiar to you all. Perhaps you have heard of Brent Johnson’s Dollar milkshake theory?
Forex, or foreign exchange (currencies), is what I tend to trade the most. In recent months I have been long the US Dollar and have had big winners as EVERY other currency against the US Dollar has fallen. Besides the Russian Ruble that is. My top trade for the year is long USDJPY and long other Yen pairs basically predicting Yen weakness. This will likely continue as the Bank of Japan remains dovish (not raising rates) while most other central banks are hawkish (raising interest rates).
But there are times when the Dollar pulls back. Nothing moves up in a straight line forever. Not even Vancouver real estate. Markets move in cycles and we should expect to see some relief. The uptrend remains, but pull backs present buying opportunities for those who missed out. I have found that when this occurs, it pays off to go long the Swiss Franc (CHF). Ideally, the Euro to Swiss Franc (EURCHF).
Why the Swiss Franc? Well I believe this situation points to fear and uncertainty. In a way, the Swiss Franc is a safe haven after the US Dollar. I mean think about Swiss neutrality, and Swiss bank accounts.
If you followed my work late last year, I spoke about the Swiss Franc breaking a key support zone at 1.05 and the major drop that was going to happen. Some said this was all conspiracy theory like, but the truth is, the financial markets were telling us that something was going to happen in Europe. European wealth was fleeing to Switzerland. A few months later, we got the Russian invasion of Ukraine. I won’t delve into it too much here but those interested should line up the Russian stock market with the EURCHF and look at price action during Fall 2021. The Russian market was one of the only equity markets that was falling. We also saw a rise in the Swiss Franc. Many people have said that Putin would lose power because the Oligarchs would turn on him. To me, it appears he let the Oligarchs know a few months in advance hence the sell off in Russian markets, and that wealth running into Swiss bank accounts. This is why I love the forex markets. It takes a lot of money to create big moves. Sometimes you just have to follow that money trail.
But let’s get back to the Swiss Franc. The EURCHF is now at parity (1.00) for the second time this year.
The Franc is getting stronger. For a nation that exports a lot, and especially to European Union nations, a stronger Swiss Franc is not desired as it can impact trade. Exporting nations prefer a weaker currency to make their exports more appealing.
Some of you might remember the events of 2015. The Swiss were holding a 1.20 EURCHF peg. The reason was for exports, and Investopedia explains it really well:
The Swiss National Bank pegged its Swiss franc to the euro on Sept. 6, 2011, which in currency years, is a very short period of time. Just prior to the Swiss franc/euro currency peg, Switzerland was an expensive place to do business. In fact, it was the most expensive place to do business in Europe; exporters and service providers had a very difficult time making profits. The solution: the Swiss franc/euro peg. This helped because the Eurozone was just exiting a crisis and the euro was lower. Therefore, by pegging the franc to the euro, Swiss exporters and service providers would greatly increase their odds of profitability.
The Swiss scrapped the peg in 2015 and created havoc in the forex market with the Swiss Franc skyrocketing 20% in a single day! I remember those days. It created havoc as traders didn’t have stop losses while trading the 1.20 peg level. Some of them woke up to owing their brokers an amount of money that would make you cry. But it wasn’t just traders that were caught out. Brokers themselves were. Large forex exchanges such as Alpari were caught out and went out of business.
A stronger Swiss Franc definitely didn’t help Swiss exporters, but to this day, many don’t know why the Swiss National Bank (SNB) broke the peg. Here are three theories floating around:
1. Switzerland doesn’t see the Eurozone as sustainable and didn’t want to go down with the ship;
2. Switzerland is aiming for franc parity with the euro;
3. Wealthy Americans with money tied up in Swiss bank accounts were seeing their investments sour due to a weak euro vs. the U.S. dollar.
My thinking was the SNB found it expensive buying foreign currencies to maintain the peg. However, looking at the above theories, if they were aiming for #2, they did achieve it but 7 years after the peg break.
This leads us to where we are now. The EURCHF is breaking below parity and is heading to 0.9660, a level the Franc saw briefly on January 15th 2015 when the peg was broken. I say briefly because in the next few days we popped back over parity.
So do the Swiss want an expensive Franc? Will they do something to weaken the Franc especially as things look dire for the European Union. July will be a big month. The European Central Bank (ECB) has said they will raise interest rates in July, but rising yields in Italy and other European nations have people second guessing. The ECB have said they will unveil some tool to deal with rising borrowing costs. It is most likely going to be buying bonds…which takes us back to quantitative easing.
A surprising recent development occurred on June 16th 2022. In a move that took markets by surprise, the Swiss National Bank raised interest rates for the first time since 2007. The central bank raised rates by 50 basis points taking rates from -0.75% to -0.25%. The reason was to signal the SNB is ready to fight inflation.
On interest rate differentials, the Swiss are at -0.25% and the ECB is at -0.50%. We expect money to flow to the higher yielding currency. Perhaps the Swiss National Bank is banking on the ECB to also raise rates thereby keeping the EURCHF stable.
Keep tabs on the forex markets. The Japanese Yen move is just the beginning. I believe we will see more volatility in this market environment. Central banks will be making tough decisions, and the idea of a currency war among central banks is not so farfetched.