Swissie will not replace yen for carry traders
COMPARED to the sharp and unexpected moves that they have previously seen, spot currency markets have been exceptionally dull of late and many major currency pairs remain range-bound with little sign of any breakout move.
Unable to rely on big daily moves in currency pairs for their profits, forex traders have returned to the popular carry trade strategy in order to take advantage of the yield differential between countries. The carry trade is the practice of borrowing in low interest currencies and then using the money to buy high-yielding assets, such as commodities, equities or bonds, often denominated in a different currency with higher interest rates. It flourishes in low volatility and low interest rate environments. The current market situation is ideal for it.
Previously, traders would typically sell Japanese yen and buy Australian dollars to take advantage of the low interest rates in Japan and the much higher rates in Australia. But with so many central banks slashing their interest rates to near zero, the carry trade is no longer as simple as it once was. Traders now have a wide choice of currencies that they could sell in order to buy higher-yielding assets. The US dollar, the yen, the euro, the Swiss franc, the Canadian dollar, the Swedish krona and the pound all offer near-zero interest rates, making them candidates for funding currencies.
UNCERTAIN OUTLOOK
However, the one currency that stands out for some traders is the Swiss franc. Among its fans are strategists from the French investment bank BNP?Paribas “The continued commitment of Swiss policymakers to prevent Swiss franc appreciation as part of the broader QE programme will make it more interesting as a funding currency, especially if the outlook for risk appetite starts to become more uncertain, as we anticipate,” they say.
As investors forecast a slip in the markets and remain concerned about the fragility of the global economic recovery, they are likely to unwind some of their positions in risky currencies, supporting the US dollar and the Japanese yen. In contrast, gains in the Swiss franc are likely to be limited thanks to the Swiss National Bank’s (SNB) strategy of intervening in the currency markets when the franc gets too strong. This means that interest rates will stay under control, and therefore make the currency attractive as a funding currency compared to the yen or the dollar.
The BNP?strategists even say that they expect the yen to strengthen at the expense of the Swiss franc not only on position unwinding, but also as a result of relative yen strength from the more domestically focused and less interventionist approach of the new Japanese government.
But other market analysts disagree, and express doubt about how long the Swiss franc could maintain its status as a funding currency for carry trades, and suggest that there are fundamental reasons that it cannot become one long-term. George Tchetvertakov, head of market research at Alpari UK, says: that “the market is almost too small and the liquidity is simply not deep enough.”
He adds: “Yes, the SNB is weakening the currency on an almost weekly basis, but traders know this is not going to last forever and rates will start to rise when the fundamentals begin to improve.”
Richard Turner, FX sales dealer at IG Index, also thinks that the Swiss franc is unlikely to become the primary funding currency of choice for carry traders. “On a trade-weighted basis the Swiss franc is actually very strong at the moment and the potential for central bank interventions make the currency much more volatile than the very quiet Japanese yen,” he notes.
LOW VOLATILITY
Successful carry trades require low volatility and the expectation that interest rates will remain low and stable. Sadly for fans of the Swissie, the good old Japanese yen still fulfils both of these conditions, and better than any other currency. Over the past two weeks, the yen has stayed within a range of 92-95 against the dollar. Just to show how stable this is, cable (sterling-dollar) saw a 250-basis point move yesterday alone.
Turner adds: “Historically there have been very low interest rates in Japan and they are not going to pick up any time soon. The Japanese will be very tepid in their approach to how they come out of this downturn.”
In the short-term, more speculative carry traders may look to sell the Swiss franc but Switzerland is simply not a large enough market and the chance of volatility is too high for the franc to establish itself long-term as a funding currency.