SNB's Fight against Strong CHF

Forex News and Events:

The FX and equity markets made an easy start to the week, the focus shifts to October 29/30th FOMC meeting. Fed expectations are clearly dovish given the weak jobs data and the recent budget turmoil (still unresolved in the long run). Fed is likely to not start tapering before the beginning of 2014; we push our target to March 2014 given the economic setting and the fragile US recovery. Walking through FOMC decision due on Wednesday, the USD consolidates weakness. DXY hit 79.998 on Friday, a stone’s throw higher than the year low of 78.918; the speculative long positions retreated to the lowest since February 2013, according to the CFTC data. Given the range-trading in the FX markets, we will recapitulate the SNB policy, talk about the strengthening CHF and share expectations.

SNB View on CHF, Expectations

As the global weakness in economic recovery and political challenges shake the financial markets, the risk-on-risk-off trades remain confusing across the board. Expectations on longer period of cheap funding (due to Fed’s extensive loose policy) triggers the risk-on rallies, while the reason behind the cheap funding – weakness in US & global recovery and fragile economic picture - is fundamentally risk-off. In this period of economic turmoil, investors’ appetite for safe-haven is naturally intensifying. CHF trades at the highest levels since March 2011 against USD despite SNB’s massive expansionary policy and solid combat against CHF strength. Where is CHF going?

In a private conference last week, an alternate member of SNB’s Governing Board made interesting comments about the SNB monetary policy and expectations. In fact, SNB’s conditional CPI forecasts show that within the next three years, the inflationary pressures will remain subdued: CPI y/y is expected to remain below 1.5% - well within SNB’s 0.0%-2.0% target band, giving no reason to SNB to tighten the monetary policy yet. Plus, according to Taylor’s rule, the SNB would better fix interest rates below 0.00% while the three month Libor target is 0.00%-0.25%. In theory, this suggests that the monetary conditions in Switzerland are not expansionary.

However, two main risks related to SNB policy threaten the Swiss economy. First, the efforts to keep the CHF-strength under control resulted in a historically high SNB balance sheet worth roughly CHF 498’500M with high currency exposure, especially to EUR (to keep EURCHF floor tight at 1.20). Second, despite the CPI seemingly under control, the dramatic increase in real estate prices represents a risk of a financial bubble in the real estate market; UBS’s Swiss real estate bubble index stands at the historical high of 1.20.

How Does SNB Fight Financial Risks?

Well aware of the financial risks partly due to its monetary policy, SNB uses diversified set of tools to manage the situation. To reduce the high currency exposure, SNB enlarges the range of currencies to diversify the FX risk, and allow keeping the EUR holding in corporate bonds and stocks. To fight the real estate bubble, SNB uses macro-prudential measures – as higher capital requirements to increase mortgage rates and various regulatory measures. All in all, SNB is committed to defend its economy, to control the safe-haven flows to CHF, yet is still a bit surprised to see that investors are still willing to pay to hold CHF, with 3-month OIS averaging below 0% since mid-12. What more can SNB do to weaken CHF?

CHF, technically…

For all those asking the question of where the Swiss franc is going, we can only insist on SNB’s ambition to keep the CHF strength under control. Yet technically, USDCHF trends down, MACD (12, 26 day) indicates that bearish trend gains momentum, 21-50-&100-dma are comfortably below the 200 dma. At the current levels, USDCHF is close to the overbought area (RSI at 32%) and tests the lower Bollinger band to the downside. An upside correction is likely (and healthy) at the current levels. Moving forward, the mid-term bias is on the downside and key support is seen at 0.8860 long term Fibonacci level from 2011 pullback.

Today's Key Issues (time in GMT):

2013-10-28T11:00:00 GBP Oct CBI Reported Sales, exp. 32 last 34
2013-10-28T13:15:00 USD Sep Industrial Production m/m, exp. 0.4%, last 0.4%
2013-10-28T13:15:00 USD Sep Capacity Utilization, exp. 78.0%, last 77.8%
2013-10-28T13:15:00 USD Sep Manufacturing (SIC) Production, exp. 0.3%, last 0.7%
2013-10-28T14:00:00 USD Sep Pending Home Sales m/m, exp. 0.0%, last -1.6%
2013-10-28T14:00:00 USD Sep Pending Home Sales y/y, exp. 3.5%, last 2.9%
2013-10-28T14:30:00 USD Oct Dallas Fed Manufacturing Activity, exp. 9.0, last 12.8

The Risk Today:

EURUSD remains bid but upside has stalled below 1.3830 critical resistance (downtrend from July 2008 to May 2011). Conditions have become overbought so it’s logical to anticipate a minor pullback to help unwind overstretched conditions (especially considering Fridays Doji on EURUSD and DXY daily charts). However, with the uptrend intact and momentum indicators solidly bullish, any downside corrections should be limited. With clearance of 1.3830 breakout level, we would look for a further extension of bullish strength to 1.4248 (Oct’ 11 high). The first region of resistance is located at 1.3830/35 then a distant 1.4248 (Oct’ 11 high). The next support can be found at 1.3647 (3rd Oct high), 1.3505 (2nd Oct low), 1.3480 (22nd Sept low), 1,3455 (20th Aug high), 1.3320 (17th Sept low), 1.3106 (6th Sept low), 1.2995 (10th July reaction high), 1.2963 (11th July low), 1.2877 (Fibonacci 50% retracement on Jul 12’ – Feb 13’ rally), then 1.2820 (20th May low).

GBPUSD Not much has changed in the GBPUSD technicals despite BoE’s M.Carney revised forecasts and expectations for GDP. GBPUSD remains trapped beneath 1.6260 despite indicators being marginally bullish. With MACD steady above the zeroline and RSI flatlined we anticipate fresh demand to challenge 1.6260 resistance (preference to buy on dips) before an extension of strength to 1.6343. Watch for next resistance to come into play at 1.6260 (1st Oct high) then 1.6343 (2013 high). The support levels from here are 1.6130 (9th Oct high), 1.6063 (16th oct pivot high), 1.5884 (13th Sept high), 1.5759 (17th June high), 1.5726 (65 dma), 1.5600 (resistance turned support), then 1.5471 (200 dma).

USDJPY has reversed course climbing to 97.75 with upside being cap by 21- DMA. Yet as USDJPY was able to push through the 200 DMA at 97.35 and damage the uptrend floor, which has amplified our bearish sentiment. Trend and momentum indicators are now squarely bearish and a close below 97.50 should trigger a deeper sell-off to 96.56 then 95.80. On the downside, supports are located at 96.56 (8th Oct pivot low), 95.83 (6th June low), 93.57 (Fibonacci 61.8% on Sept 12’ – May 13’ rally), 92.56 (2nd Mar low & Fibo 38.2% retracement), 90.93 (25th Feb low). The first resistance region is located at 99.00/15 (Fibo retracement from Sept –Oct fall), 100.68 11th Sept high), 101.50/68 (8th July high & Fibo lvl), 102.53 (29th May high),103.55 (16th Sep 08 & 30th Sep 08 low), then 105.00 (psychological resistance).

USDCHF is entrenching its sideways pattern between 0.8889 to 0.8967. With MAC below the zeroline and stochastics crossing over we suspect further downside should be anticipated (corrections will be short lived). We would be a seller on rallies for a move to 0.8860. The first levels of support remains at 0.8934 (24th Feb low), then 0.8860 (Fibo 38% Aug 2011 to July 2012 retracement level). The next levels of resistance are located at 0.8970 (support turned resistance), 0.9139 (24th Sept pivot high), 0.9450 (target), 0.9481 (range top), 0.9568 (fibo 61.8% on May-June drop), 0.9598 (11th July high), 0.9626 (31st May low & 3rd June low) then 0.9672 (fibo76.4% level on May – June drop).

Resistance and Support: