Buying EUR/CHF anywhere close to 1.20 will turn out to be the easiest trade of 2011. I bought the pair on Sept. 9 at 1.2066 and with a stop at 1.1945.
The story is well known. The Swiss National Bank pegged the franc to a minimum of 1.20 against the euro on Sept. 6. The result was a 10%, one-day move in EUR/CHF to slightly above 1.20 from 1.1019.
The press release announcing the decision (http://www.snb.ch/en/mmr/reference/pre_20110906/source/pre_20110906.en.pdf) will go down in foreign exchange history. I spoke to a trade who put on a EUR/CHF long in the morning (with no limit), went to the beach and came home $10,000 richer. He said it was the best day of his life.
The SNB said it will enforce the peg “with the utmost determination and is prepared to buy foreign currency in unlimited quantities.” They are aiming for “a substantial and sustained weakening” of the franc and “will no longer tolerate” EUR/CHF below 1.20.
Most traders are stupid and the first thing they thought about was fighting the SNB the way Soros fought the Bank of England. (http://www.investopedia.com/ask/answers/08/george-soros-bank-of-england.asp#axzz1Y4w7gDfD)
This is nonsense. Britain was attempting to boost the value of its currency while the Swiss are attempting to devalue. Weakening a currency is easy, you just print more of it. In Switzerland’s case, they are printing it and buying European bonds. There is no limit to how much they can print and spend.
The second point to consider is credibility. I quoted the strong wording of the SNB because they have placed themselves in a corner. There is no way to back down. If they fail here, especially if they fail quickly, it would take years to restore their previous clout. Central bankers are extremely observant and protective of credibility and they’ve put every ounce of it on the line here. In doing so, they surely considered all the possible outcomes, including extreme turmoil in the eurozone.
The third point is carry. As in the money earned on interest. The CHF rate is 0.25% and the euro rate is 1.50%. Even if EUR/CHF stays precisely at my entry point the trade pays 1.25% per annum. With leverage, it’s much more. Over time, as the SNB demonstrates credibility, the carry trade will boost EUR/CHF.
These three reasons are more than enough to enter this trade. The fourth reason is a theory. The chief loser in this decision is the eurozone yet there has not been a single complaint. Swiss companies are now competing with their European counterparts at below-market rates. The secondary losers are the rest of the free-floating currency world, who also must compete with the Swiss at rate that doesn’t respect the market. Granted the CHF was in the midst of a tremendous rally prior to the announcement but, still, the international community has been silent at a time when rhetoric about unfair Chinese FX devaluation has ramped up.
Maybe there was an agreement prior to the SNB announcement. What would Europe want in exchange? It’s obvious. The SNB buying European bonds is mutually beneficial. It will lower borrowing costs and stabilize Switzerland’s trading partners. Specifically, I expect the Swiss to buy the bonds of neighboring Italy and France. For the rest of the world, an improvement in the stability of the eurozone is a small price to pay for giving up a slight competitive advantage to Swiss exporters.
Another curious event around the peg that raises my suspicions is the leak. It’s obvious that some traders had foreknowledge of the decision. EUR/CHF rallied 250 pips in the two hours before the decision.
It’s certainly possible that someone at the SNB leaked the decision. The knowledge was extraordinarily valuable. Even a small retail trader could have easily made $100,000. In 15 minutes with that information, I could put on trades that would net $1 million. A well-funded trading operation could easily have made $1 billion.
If you think those numbers are outrageous consider that UBS rogue trader Kweku Adoboli apparently lost $2 billion of his employer’s money on the CHF devaluation (http://www.zerohedge.com/news/ubs-rogue-trader-had-been-reduced-watching-fox-news-guidance). His employer? UBS, the Swiss banking giant. If anyone in Switzerland had foreknowledge of the peg it would have been them, and they certainly wouldn’t have lost $2 billion.
I don’t believe the leak came from the SNB. They’re Swiss bankers, people famous for keeping their mouths shut.
But if they discussed and cleared the plan with their neighbours, the secret would have been much more difficult to keep quiet. Perhaps the Italians talked? Perhaps the French? If we could follow the money, we might find out. But instead, let’s make money in our own way – trading forex.
The next question is: how high will EUR/CHF go? The SNB said the franc “is still high and should continue to weaken over time.” This tells me they are unlikely to act in order to drive EUR/CHF higher unless the economic outlook deteriorates or deflationary risks mount.
In this case, the unwind of specs, the aforementioned carry trade and an improvement in the European sovereign crisis will drive EUR/CHF to 1.25 and beyond. Yes, I said and improvement in the sovereign crisis. Greece will receive the next tranche of aid and that will eliminate any risk of default through year end. This alone will help stabilize EUR. Switzerland and other nations buying European debt will further fuel the trade.
Technically, EUR/CHF has bottomed and will continue to reverse. A clear inverted head-and-shoulders pattern is visible on the daily chart. And though the measured target of 1.39 is far fetched in the near or medium term, the direction is certainly up.
I will hold this trade until it hits 1.35 or until mid-December, whatever comes first.