G10 FX Weekly: EUR/CHF Rally Has Legs

Summary

• After rallying on haven demand late last month, the Swiss franc (CHF) has weakened in February.
• Weaker-than-expected Swiss inflation data drove the decline, with imported product prices sliding.
• This indicates the currency is weighing materially on inflation and has prompted the market to price a strong probability of an SNB rate cut next month.

Market Implications

• We continue to like CHF downside.
• We still think EUR/CHF can trade back to the November highs of 0.9650/0.9700.

Buying Dips in EUR/CHF Has Been Fruitful

We have liked buying dips in EUR/CHF since 18 January, expecting the pair to return to the 0.9650/0.9700 highs last seen in November.

At that time, we highlighted a shift in SNB messaging, tilting away from supporting CHF, as the key to the expected currency weakness. Valuation and crowded long positioning were other reasons for expecting CHF strength to reverse.

Price action has been choppy over the past month. However, buying EUR/CHF dips has proven effective.

Swiss CPI Lifts EUR/CHF

A broad miss in January Swiss CPI on Tuesday has lifted EUR/CHF to the strongest level since mid-December.

Every measure in the data release surprised to the downside. The headline reading was 1.3% vs 1.7% expected YoY, 0.2% vs 0.6 expected MoM, with the core reading 1.2% vs 1.6% expected YoY. Both YoY readings are below the 2% SNB target.

Both MoM (-1.3%) and YoY (-0.9%) ‘imported products’ readings plummeted, reflecting the strength of the currency. This supports the warning from SNB President Jordan at Davos last month that CHF strength is becoming a challenge in Switzerland and is weighing on inflation.

EUR/CHF Price Action Has Been Choppy

For the first time in several weeks, domestic Swiss news was the primary driver of EUR/CHF price action.

The pair rallied when Jordan spoke at Davos last month. Yet it quickly reversed those gains and traded sharply lower on the back of three non-Swiss drivers late last month.

These were:

1. The dovish market reaction to the ECB rate decision and messaging, which weighed on many EUR crosses, including EUR/CHF.
2. The CHF also benefitted from a flight to quality in late January, with geopolitical concerns, especially in the Middle East, prompting CHF buying.
3. There was also a sharp leg lower in EUR/CHF due to initial fears about New York Community Bank, with CHF haven buying intensifying.

Each driver of CHF strength has dissipated markedly, and EUR/CHF has slowly recovered in the past couple of weeks.

EUR/CHF Has Entered a Resistance Zone

This week’s EUR/CHF rally has taken the pair into a resistance zone, within the ~0.9450/0.9550 range.

Chart 1: Orange line = EUR/CHF price

The rally this week took the pair slightly above the ~0.9470/75 high seen last month before the sharp selloff, and the price now exceeds it.

We have bought the dip and remain long EUR/CHF. However, we would like to see the pair convincingly exceed the ~0.9450/0.9550 resistance zone outlined above.

SNB Rate Cut Could Prove a Major Catalyst for EUR/CHF

In addition to kickstarting the rally in EUR/CHF, the January inflation data also ratcheted expectations for an SNB rate cut next month considerably higher.

Before the data release on Tuesday, the market priced ~10bps of easing for the next SNB rate announcement on 21 March (or a ~40% probability of a 25bp rate cut).

At the close of business yesterday, following the inflation data, the market priced just over 17bp of easing next month, or roughly a 70% probability of a 25bp rate cut.

This is the highest probability of a March SNB rate cut since December when the market reacted dovishly to the SNB’s monetary policy update.

Chart 2: Orange line = March 2024 SARON Contract Implied Yield

Back in December, markets priced an ~80% probability of a 25bp SNB rate cut in March.

Should the move this week gain further momentum ahead of the SNB rate announcement on 21 March, we expect EUR/CHF to continue to rally.

Richard Jones writes about FX and rates markets for Macro Hive. He has traded and invested in interest rate and FX market portfolios spanning three decades, both on the buy-side and sell-side.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)