Central Bank Stance Suggests Continued Downside in Swiss Franc

NEW YORK ( TheStreet) -- Price moves in the euro/Swiss franc foreign exchange pair have been relatively steady since the Swiss National Bank (SNB) enacted its 1.20 price floor toward the end of 2011.

Initially, these measures were enacted to stall gains in the rapidly appreciating Swiss franc, prevent deflation and provide a means for keeping the country's export-driven economy from falling into recession. With only one brief foray below the 1.20 level since then, long positions in the EUR/CHF have proven to be one of the surest bets in the forex markets for the last two years.

But the next question for EUR/CHF traders, and those holding the CurrencyShares Swiss Franc Trust ETF ( FXF), centers on the timeline for when this price floor will be removed. Since 2011, the Swiss currency has rarely moved in relation to macroeconomic fundamentals, so at this stage it is clear that the next real trend will depend on the intentions of the SNB.

SNB Comments

Early clues have already been seen this week, as SNB Vice President Jean-Pierre Danthine made public comments suggesting the EUR/CHF price floor will be removed once interest rate conditions start to normalize. Removal of the EUR/CHF price floor would almost certainly send the Swiss franc to new long-term highs (which means new lows in the EUR/CHF currency pair). But when we look at the additional details provided by Danthine, it becomes clear that the franc will not see rapid appreciation any time soon.

Specifically, Danthine said the SNB will not be in a position to restrict minimum exchange rates once the central bank finally moves into the tightening phase of its rate cycle. But he went on to say that maintaining the price floor in the current environment continues to be a central priority for the central bank, and that it is unlikely we will see any changes in interest rates until 2015. Benchmark interest rates in Switzerland have already been cut to zero, so the overriding bias at the SNB is clearly geared toward accommodative policies.

So, while instruments like the CurrencyShares Euro Trust ETF ( FXE) should continue to outperform the Swiss franc during this period, it is also important to remember that this is not a permanent trade. House and apartment prices in Switzerland have surged in the last few years, as loose policy settings at the SNB enabled banks to offer cheap mortgages.

The SNB has hinted that a housing bubble might be forming, and the government has already started requiring banks to retain larger amounts of capital as a buffer in preventing excessive loan defaults. If borrowers are, in fact, over-extending themselves, real problems could be seen if the market is not prepared for a rising interest rate environment.

But it is also clear that banks have moved toward higher risk profiles, based on the assumption that low interest rates will remain in place for the foreseeable future. With this in mind, traders can expect the EUR/CHF to hold above 1.20 for the foreseeable future, as the timelines presented by Danthine and others open the way for long term positions with excellent risk to reward prospects. Any dips in the EUR/CHF toward 1.20 should still be viewed as a strong buying opportunity, and these calls will likely remain in place at least until the end of next year.

FXF Chart Perspective

The fundamental picture supports the argument for additional downside, and there is agreement from chart perspectives as well. The steady series of lower highs since the end of 2011 is suggestive of a consistent bear trend, and the downward resistance line created during that period coincides with the 100-week moving average, acting a strong level of resistance. Look to sell FXF on an approach to 106.40.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Richard Cox is based in China, and has lectured at several universities there on international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of Web sites, including MarketBulls.net, Seeking Alpha, FX Street and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.

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