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Written in Dec 2013: FX trade of the Future is EUR/CHF Short, Not EUR/CHF Long

UPDATE after end of the peg:
Some people doubt that the article is really authentic and not modified after the peg.

Here the wayback Internet archive as of April 1, 2014 and July 2014:

In response an ForexLive.com article on gains on EUR/CHF long:

The EUR/CHF long was a nice trade during winter/spring 2013, when European austerity compared to American consumer spending fueled risk appetite in favor of the US. This gave the impression that only the US will grow in this world and that eventually the Fed will hike rates earlier than others (e.g. ECB or SNB). Consequently the EUR/CHF appreciated to 1.26. But investors have understood that the FX world is cyclical, that the next ones to expand were the Brits and now the Germans. It was not unexpected, one year of QE3-induced US spending lifted the German trade surplus and filled the pockets of German companies.

The German or Swiss services PMIs, the most reliable GDP proxy, are now close to 56, the US non-manufacturing PMI is considerably lower and French or Italian ones are below 50. Be aware that the German economy ultimately drives the Swiss franc, higher German growth or higher German inflation will strengthen the Swiss franc.

In a world of near zero interest, trade flows, i.e. which countries have the highest trade surpluses, and the asset market model aka capital flows into equities, i.e. which companies have highest profits, ultimately decide FX rates.  FX traders are nearly irrelevant for FX rates, they manage to accentuate some trade or capital flows.

Thanks to (relatively) cheap but qualified labor immigration into Switzerland and price-insensitive quality production, the Swiss trade surplus continues to increase. Thanks also to immigration and low taxes, Swiss companies have a structural advantage against the rest of the world. Moreover, they profit on their global incomes.

In addition to a small rate difference of only 0.25%, inflation differences between EU and Switzerland have fallen from 3.9% to 0.7%. Swiss food prices are up 1.7% YoY, French ones only 0.2%, and many Swiss are wealthy enough not to care about rising prices, which again would boost company profits. Therefore the EUR/CHF long has become a very difficult trade.

This implies that EUR/CHF should move closer and closer to 1.20.  If you buy EUR/CHF, buy it low, it will always rebound for a certain period. Jordan should be on your side for at least another 2 years.

Remember that CHF is not JPY: Japan has no immigration, it has a trade deficit and wages still do not rise: salaries have been flat for more than a decade (no problem if you have deflation!). Higher rates and bond yields would increase the Japanese debt enormously.

The SNB is a very hawkish central bank and not as dovish, as many analysts think

SNBpic.jpgTo think that the SNB will always save your trade is wrong. As opposed to what analysts think, the Swiss are not a dovish central bank but a very hawkish one. The Swiss people are world-wide creditors and very hostile to eroding purchasing power and inflation, this hostility is enshrined in the SNB mandate. One second major aim of the central bank is to avoid a repetition of the 1990s real estate and banking crisis. Far less important and not contained in the law are potential losses on SNB investments.

The SNB will be able to live with the EUR/CHF of 1.10 in 4 or 5 years (and maybe with parity to the euro in 10-20 years). There will be some SNB losses, but a stronger CHF will reduce Swiss bond yields and therefore Swiss debt. The SNB still earns more than 2% yield per year on its US or German bond holdings and even more on its stock holdings (recently 16% of the portfolio). Over 5 years this is enough to cover a 10% loss on CHF. SNB losses on gold positions are currently an issue, but, over the long-term, emerging markets and inflation will rise again and the central bank should have gains again in gold.

Short EUR/CHF was already

  • a good trade in 2009, when at inflation levels of 1% the SNB gave up the “line in sand” of 1.50 (read the history episode)
  • a nice trade in 2010, when at inflation levels of 1% the bank gave in the 1.40 level (read the history episode)

Read here the history of SNB interventions.

Therefore, the best future FX trade is to short EUR/CHF and not to look at that position for some years. The time of the EUR/CHF long trade is slowly running out. Better earning once 1000 bips with a EUR/CHF Short than winning 20 times 30-50 bips and getting 80 times stopped out with a EUR/CHF Long.

P.S.: The reader might think that the cyclical argument above also applies for the European periphery. Looking back at the six or seven years, the U.S. needed to come out of the crisis, we judge that the weak European countries will need the same time, due to structural constraints and emigration (e.g. into Switzerland) possibly even more. After that time, seven years after the euro periphery crisis of 2011, in the year 2018 Germany and Switzerland might already  fight against inflation, while the periphery will be fully recovering.

In this scenario it is clear that the euro will rise against the dollar: The Euro is Poised for a Rise, Expect $1.50 

George Dorgan
George Dorgan (penname) predicted the end of the EUR/CHF peg at the CFA Society and at many occasions on SeekingAlpha.com and on this blog. Several Swiss and international financial advisors support the site. These firms aim to deliver independent advice from the often misleading mainstream of banks and asset managers. George is FinTech entrepreneur, financial author and alternative economist. He speak seven languages fluently.
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