EURCHF: will the SNB defend the 1.20 peg?

Since the Swiss National Bank (SNB) imposed its peg in EUR/CHF, this cross has only traded below 1.20 a handful of times, and each time it has bounced off this important level of support. In the three years that the peg has been in place, the market hasn’t tested the SNB’s resolve with any gusto. The market has seemed to accept that you don’t push EUR/CHF below 1.20, otherwise the SNB will act and you could get burnt.

The SNB has kept its commitment to the peg, however, if the ECB embarks on a programme of quantitative easing in the coming months, as some expect, then it could become a lot more expensive for the SNB to defend the 1.20 level if the EUR weakens substantially from here.

If the SNB was to pull the plug on the peg then there could be a sharp reaction in EUR/CHF as pent up demand could trigger fresh shorts below the 1.20 level. However, we continue to think that the SNB will do everything that it can to defend the 1.20 level. Swiss inflation is already at 0%, and a stronger CHF would only make this deflationary problem worse. The Swiss authorities have been increasing their foreign exchange reserves, which are now at their highest ever level, at CHF 453bn. This is quite a war chest and suggests that the SNB won’t give up the peg without a fight.

The technical view:

EUR/CHF is testing a critical level of support after a sharp sell-off in recent days. 1.2064 is the low from 31st December 2012. A break below this level would be a further negative trending/ momentum indicator and could pave the way for more downside towards 1.2030 – the November 2012 low, which then leads the way to 1.20 – the SNB’s peg.

While we think that there could be room for a test of 1.20, any move back towards 1.1980- 1.2020 could be met with a wave of EURCHF strength. If that happens, it is likely to be the work of the SNB. Since the market has respected the SNB peg for most of the last 3 years, we would be surprised if there isn’t some trepidation around this level. We think there will be plenty of buy orders around 1.1980- 1.2020 as the market tries to jump on the back of a wave of EURCHF buying.

Thus, in the short term, there could be 60 pips or more of further downside, but around 1.20 we could see a sharp reversal as the SNB tries to get EUR/CHF out of harm’s way, so be careful of crossing the SNB at this important level. Key resistance lies at 1.2112 – the 38.2% retracement of August’s decline.