G10 FX Weekly: Table-Topping CHF to Keep Outperforming in H2 2023

Summary

• The Swiss franc (CHF) is the strongest G10 currency so far in 2023.
• The Deutsche Bank CHF Trade-Weighted Index (DB CHF TWI) trades at a multi-decade high.
• We think the CHF will continue outperforming its advanced-market currency peers in H2 2023.

Market Implications

• Bullish CHF TWI – The CHF TWI is up about 4.4% year-to-date (YTD) and, although possibly due a pullback, we like buying any dips.
• Bullish CHF versus the pound (GBP), euro (EUR) and Japanese yen (JPY) – To varying degrees, each pair may also be due a shallow retracement of CHF strength. Again, though, we view any CHF pullbacks as corrective, buying opportunities.

Introduction

The Swiss franc is the strongest G10 currency so far this year, narrowly outpacing the surprisingly resilient British pound to top the 2023 leaderboard.

This is impressive given the franc has not particularly benefitted from the haven flows usually associated with CHF outperformance.

Equity markets have been buoyant and, despite episodic turbulence this year (e.g., the political drama in Russia last month), geopolitics have been subdued compared with 2022.

We think CHF outperformance can continue in H2 2023. The Swiss macro backdrop is favourable relative to its G10 peers, the Swiss National Bank (SNB) remains committed and credible in its fight against inflation, and the currency might yet benefit from prospective haven demand.

CHF TWI at Multi-Decade High

We wrote about our bullish CHF bias back in May. Since then, the currency has stayed top of the G10 currency charts. So far this year, the DB CHF TWI is up ~4.4%

This CHF currency basket – comprising 70% EUR/CHF, 15% USD/CHF, 9% GBP/CHF, 5% CHF/JPY and 2% CAD/CHF – currently trades at a multi-decade high.

The Swiss Inflation Backdrop Stands Out Positively

The obsession of central bankers worldwide over the past 18 months or so has been taming inflation. And except for the Bank of Japan, authorities have tightened monetary policy considerably throughout the G10 (and beyond).

The results have varied. In the UK, for example, inflation remains stubbornly high (although the most recent CPI readings were more encouraging).

Things look better in the Eurozone and the US. Inflation is slowing and, most importantly, returning to ECB and Fed targets.

The lowest inflation readings in the G10, however, are in Switzerland. Last month both headline and underlying inflation in Switzerland returned below the SNB’s 2% ceiling. The most recent year-on-year measures printed 1.7% and 1.8%, respectively, both comfortably the lowest levels in the G10.

The SNB’s Aggressive Inflation Fight

The SNB has acted decisively in tightening monetary policy to offset elevated inflation in Switzerland.

Over the past year or so, the central bank ended its negative interest rate policy (NIRP), which had been in place since January 2015.

In sum, the SNB raised rates 250 basis points (bps) since beginning its tightening cycle last year. At its most recent meeting on 22 June, Swiss policymakers raised rates by 25bps to 1.75%

The SNB has also been selling foreign currencies to bolster the CHF, thereby offsetting imported inflation. A very sharp rise for the franc could see the SNB cease selling foreign currencies and intervene in the opposite direction to stem CHF strength.

However, the orderly CHF ascent this year will not prompt the SNB to push back. This is because fighting inflation remains the SNB’s top priority, and supporting a strong CHF is a powerful weapon for the SNB in this fight.

Recent SNB Messaging and Current Market Pricing

The most recent SNB messaging has maintained the almost mantra-like assertion that further rate increases cannot be ruled out, given the persistence of inflation.

SNB Vice Chairman Martin Schlegel said earlier this month that despite the recent moderation in Swiss inflation readings, underlying price pressures have continued to rise.

Market pricing also points to additional policy tightening in Switzerland. There is roughly a 75% probability that the SNB will raise rates by 25bps before yearend.

CHF Is Up Despite Strong Equities and (Relative) Geopolitical Calm

Traditionally, the Swiss franc has performed well in periods of risk aversion: when the global economy has faltered, leading to a decline in equity prices, and when geopolitical risk has been elevated.

Recent examples of haven CHF demand include the global financial crisis in 2007/2008, the European sovereign debt crisis a few years later, and last year when the Ukrainian war began.

But strikingly, CHF has outperformed this year even as equity markets rally sharply. The S&P 500 is up ~19% YTD, the Nikkei 225 is up ~25%, and the Euro Stoxx 600 index is up ~10%. Additionally, geopolitics has been calmer than last year.

At the same time, the Swiss franc is the strongest G10 currency. This demonstrates that the currency has begun to show an ‘all-weather’ resilience for 2023.

CHF Haven Demand to Increase if Traditional Risks Emerge

Should haven demand rise due to escalating geopolitical tensions or a deep economic slowdown, CHF appreciation will almost surely accelerate (as we argued in May).

While geopolitical tensions are nearly impossible to foresee, economic slowdowns are a bit more (if not entirely) predictable.

For example, we can look at the US 2s10s calendar spread. The Macro Hive US inflation model currently assigns a 94% probability of a recession in the next twelve months. The Fed’s model, based on a similar calendar spread methodology, assigns a 67% probability of a recession.

The 2s10s spread in the US is currently inverted (by 97bps). Deep curve inversion is also present in Germany and the UK, plus other G10 interest rate markets.

Should the G10 interest rate curves be correct in predicting a recession across developed markets, expect the CHF to benefit materially from haven demand.

Some Favoured Trades

We expect CHF to continue its H1 2023 outperformance of G10 counterparts for the rest of this year.

The franc is up about 7.6% versus the USD so far this year, outpacing all other G10 currencies. We looked at USD/CHF last week as part of our broader USD piece.

This week we look at GBP/CHF, CHF/JPY and EUR/CHF.

Bullish CHF vs GBP

We think the franc could rally most against the pound in the G10 currency space in the coming months.

The pair’s YTD high printed about one month ago. Since then, the franc has rallied ~3% versus the pound.

With the Bank of England probably set to slow its tightening cycle and UK yields set to drop, we expect broad GBP weakness to accelerate through yearend. The franc will be the biggest G10 beneficiary of sterling’s decline.

Bullish CHF vs JPY

Since we wrote about CHF/JPY on 4 May, the pair has risen ~7%, currently hovering near its all-time high.

At that time, we expected continued outperformance of the franc over the yen. Nonetheless, the pace of the ascent has been surprising. However, as we noted in May, this trend has broadly been in place for the past 15 years or so.

Given the speed of the CHF/JPY rise, we are probably overdue a downward correction. Nonetheless, we expect any price pullback to be shallow and short-lived.

And, while the eye-watering YTD performance of the pair (up ~15%) will moderate in the coming months, we still expect the pair to print a marginal new YTD high before year-end.

This is especially true if the global economy slows and haven demand grows. In these instances, the franc has consistently outperformed the yen.

We expect the same dynamics to play out next time around.

Bullish CHF vs EUR

So far this year, EUR/CHF has declined about 3.6%.

Unlike in CHF/JPY, the franc’s move has been more orderly and contained, but the YTD downward trend has been clear.

We expect the slow appreciation of the franc against the euro to continue into yearend.

Although we see both the euro and the franc among the best G10 performers in H2 2023, the looming threat of an economic slowdown in the Eurozone could drag on the single currency.

As such, we expect EUR/CHF to edge lower for the remainder of 2023. As with the other pairs, the CHF may be subject to some modest downside (i.e., an upward retracement in EUR/CHF), but we think the move will be minimal and corrective.

The pair’s recent intraday low was ~0.94 last September. We expect EUR/CHF to revisit this level in the coming months.

Richard Jones is a Macro Strategist for VDK Capital, a London-based venture capital firm. He has traded and invested in interest rate and FX market portfolios spanning three decades, both on the buy-side and sell-side. 

Photo Credit: depositphotos.com

(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.)