EUR/USD Outlook January 16-20

EUR/USD Outlook January 16-20

From forexcrunch.com

Euro/dollar had another roller coaster week which ended in a fresh 16 month low.The upcoming week features the important ZEW survey and inflation numbers in addition to other events. Here’s an outlook for the upcoming events, and an updated technical analysis for EUR/USD. At first, things were looking good for the euro – the single currency enjoyed Draghi’s confidence regarding the success of the LTRO operation. The aversion of a credit crunch is far from certain, after Friday’s events. France lost its perfect AAA rating, together with other euro-zone countries. In addition, Greece is on the brink of default ... (full story)

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Jan 15, 2012 10:53am

EURCHF, the “floor”, SNB and other fondues

The Swiss franc has a history of being a safe haven currency for longer than I have been in the market. In fact – the year I started – the currency was in focus as much as it is these days – for almost the same reasons.

One can wonder why a small country with a small economy got a currency with such attraction. It’s never had high interest rates, Swiss banks are not particularly client friendly – still this is the currency you go for when everything else looks shaky.

Two times throughout my FX life I have seen Swiss deposits giving negative return – as a consequence of 0% interest rates and some juicy fees for depositing CHF with Swiss banks. You had to pay if you wanted CHF deposited with Swiss banks.
Even in more normal times – the currency is not yielding more than 0.25% or so.

The Swiss economy is export oriented and has historically been very strong. As such – there is no surprise that their currency is a strong one. The excessive strength – on the other hand – comes from flight to safety financial transactions – totally uncorrelated to the underlying strength of the currency.

For the Swiss National Bank (SNB) it has always been a struggle to balance the strength of the currency from safety status with the need exporters have for a lower currency. It’s been a classic currency policy question to deal with for 50 odd years.

Because of this SNB has been an active participant in the FX market – and more active than any other central bank – for a long time. As such – they are pretty experienced in dealing with currency issues, knowing how the market works, etc.
Interventions are almost on their agenda every month – and in periods almost daily.

The main purpose of SNB interventions is to weaken the CHF to help the export industry. They sell CHF and buy currencies. Most Swiss exporters’ price their products in CHF so a net surplus to the trade balance is accumulated CHF – which through various ways ends up in the national bank – which again is utilized by the SNB for this purpose. As such – SNB also accumulates big foreign exchange currency reserves – currently at 250 billion Swiss francs or thereabout.
Because of the great interest in CHF, the SNB has for as long as I can remember had a low interest rate policy – simply to attract as little of CHF as possible.

In a low interest rate environment – as seen for most currencies today – the CHF increases its attraction as interest rate differentials to other currencies are small.

15 years ago this was different when several European currencies were high yielders – with interest rates in excess of 10%. Then – CHF was often shortened in a carry trade model where investors would go long in high yielding currencies. During such times, interventions took place the other way – with the SNB buying a bit of CHF to keep the CHF as stable as possible.

Whenever storms arrived carry trade models would be liquidated and CHF bought again – and SNB would intervene as they do today.

Lately 0% interest rates and fees to keep deposits with Swiss banks have proven to have limited effect on the attraction of the currency. As such – interventions have become more frequent and more substantial in terms of volume.

In 2010 the SNB was not performing well in terms of intervening at optimal times. They simply didn’t have the power, the strength and timing right when attempting to weaken the CHF. Market “overruled” what they did and continued buying the currency. The SNB ended up with a lot of long currencies – short CHF positions which at the end of the year had a market to market value of – 20 billion CHF. Interventions that year were in the region of 100 billion CHF being sold.

Mr. Hillebrand was very much criticised for this intervention policy, which by Swiss politicians was looked upon as a failure.
Last year he got the policy committee of SNB to agree to a floor for EURCHF, which so far has proved to be much more successful - at least for as long as the floor has not had to be defended.

Putting a floor for EURCHF makes sense as the biggest export market for Swiss exporters is the Euro-zone area. The more stable that currency pair is, the better for exporters.

It has long been anticipated that 1.4000 would be the optimal exchange rate – as seen by Swiss economy. Putting the floor @ 1.2000 must therefore be seen as a first step on the road to a weaker CHF level.

The market has been expecting a new floor level on several occasions over the last five months – but then – nothing happened. As such – speculators turn their attention to the strength of the existing floor and likely are attempted by testing this out. As such – you have seen long EURCHF being liquidated lately and more focus has been drawn to the 1.2000 level the closer we get.

Where will they start defending the level – some pips above – or will they wait until the price is there and then just set out a 1.2000 bid.

That’s where we are at moment.

The way the floor will work – as it is communicated – is that bank can sell EURCHF to the SNB and SNB will pay 1.2000 for those EURCHF. They have indicated that they have more than CHF 50 billion of funds available for such interventions and

I have the suspicion that they also have agreements with other central banks to assist them, should that be required. Again –it is the strong wording of unlimited intervention possibilities that to me implies that other central banks also can get involved selling CHF.

Now – do they wait until the rate is 1.2000 before doing anything or do they stick their neck out and intervene also at weaker CHF levels – like 1.2075, 1.2050 – or wherever?

The answer to that is likely yes – but where and when and with how much – you will never know in advance. The reason they would do it ahead of 1.2000 is likely only to give the market a warning they SNB is watching you and if you are getting too close to the protected area – they will be there.

The market can react to this in more ways. If they see this as a determination by the bank, they might withdraw their CHF buying interest pretty quickly and SNB’s warnings served its purpose.

I would be surprised if the first interventions would not take place a bit ahead of the floor level for the reasons set out above. But in terms of SNB – one of their strength is their unpredictability.

They are pretty good reading the market and market participants. You can be sure that if you have a view on what you think they will do, they will know that you think that way.

They only use Swiss banks for interventions – and only a handful of them. There is a mutual understanding between the SNB and Swiss banks – that nothing is communicated to the market before SNB has completed whatever they wanted to do. As such – other market participants will not know when interventions take place before it is all done.

So – I expect some warning interventions to take place on an approach to 1.2000 – and I expect massive defence of the exact floor level by SNB keeping a 1.2000 bid for as long as they have ammunition to do so – with or without the help of other central banks. They simply have to – the way the floor has been communicated and defended verbally.

Whether they have the strength to do so for an “unlimited” amount remains to be seen.

The way the market acts at moment is an indication that they want to challenge the floor. As cu there could be pretty much of a “war” around the 1.2000 level.

The only scenario I can see where they would abolish the floor would be a scenario where the financial world is “falling a part” and it is a one way road for all investors to get out of all kind of risks and into safe haven assets. In such a panic scenario – I think SNB might temporarily abolish the floor and then reinstall it later. But this is only in a scenario where “the world falls apart”.

The current long EURCHF are set out with stops tight below 1.2000 and should the floor not hold, those stops will not be executed @ 1.1950 – where they likely are set out – but more likely in the area 1.1750-1.1500. You don’t do 25+ billion Euros of stops within 50 pips – it’s simply not possible.

My thinking about what I think SNB might do goes along the following lines:

They have had some reservations about raising the floor for likely two reasons: It is too much of a “risk off” climate in the financial system and as such, Swiss franc could become really attractive to buy – should it be put lower in value first. Such lower value you get from a higher floor. As such – a higher floor and a lower CHF might trigger more of CHF purchases.

Secondly – and likely equally important – is the current long EURCHF positions waiting a higher floor. These are long from 1.2000-1.2400 and they will be seeing 1.25, 1.30 or whatever the next level would be – as a gift to unload the longs. As such one would expect a new and higher floor level to be defended immediately.

What I think the SNB would like to do – should pressure mount – is to keep the floor defended – thereby buy the EURCHF longs from those selling – for whatever amount necessary. Not higher than the floor – but constantly keeping the floor level through bids.

Should the pressure mount – then longs will be out and possibly replaced by shorts – as speculators anticipate the floor to break.

At such time – SNB should raise the floor – to 1.2500 and at the same time say that this is the second step of more steps to come.

A higher floor at such time when the market is short EURCHF – will trigger stops from shorts and losses among speculators.

Do this a few times – and some of the interest in speculating against the CHF – might disappear.

This would be my preferred way of doing this – it has substantial elements of risk – predominantly from that the SNB must be able to take out all long EURCHF positions the market sells them – and preferably more than that – ideally to the level where the market becomes short EURCHF.

When introducing the floor in September they caught the market heavily long CHF – and that’s why no interventions were needed when setting the floor – not to get there and almost nothing afterwards.

The situation now is different – and therefore more risky for SNB.

Will they succeed defending the floor? I think so – but it is depending on that they – alone or together with other central banks –are in a position to take out ALL long EURCHF positions offered to them. If they do not have the shots to do that – then the floor is likely not possible to defend should the market decide to challenge it.

I went long on stages after the floor was introduced and I sold my longs partly @ 1.2450 and partly @ 1.2390. I’m interested in going long again as close to 1.2000 as I see possible. Now – it is necessary with a stop for a long EURCHF and as most of them are placed just below the 1.2000 – it will be a massacre should the floor break. I presume stops will be executed far below this level and not where originally put in.

As such I will put my stop just above 1.2000 and stay sidelined should the “war” around 1.2000 start.

from Tor

Bakker

Jan 16, 2012 7:53am