BNY’s Geoff Yu argues that Swiss Franc (CHF) positioning looks stretched as investors bet on policy tightening that the Swiss National Bank (SNB) is unlikely to deliver. He highlights subdued Swiss inflation, soft Gross Domestic Product (GDP) data and the risk that an European Central Bank (ECB) hike further dampens external demand. Yu notes that conditional inflation forecasts leave little justification for SNB rate hikes and sees policy remaining cautious.

Franc overheld versus Euro on policy mispricing

"As a generally zero- or even negative-yielding currency, the franc is rarely in an overheld position due to carry loss. There is passive hedging in place by CHF-denominated investors, but beyond regulatory mandates, we doubt such purchases are strongly encouraged – they conflict with the SNB’s general approach of deterring CHF purchases in normal times. Hence, when CHF moves into overheld territory on a standalone basis and is even better held than EUR, circumstances must be “abnormal.”"

"With the ECB moving toward a rate hike, circumstances are still very different, and there’s little chance the SNB can suddenly shift course. Headline inflation continues to run at relatively “normal” levels on a sequential basis, while Q1 GDP (sports-adjusted) surprised to the downside. There’s simply no demand-driven inflation impulse; if anything, the ECB’s hike will further slow demand among Switzerland’s key trading partners, and the SNB may even view hawkish policy as a risk to Swiss growth."

"Fundamentally, we continue to see a glaring inconsistency in how the market actually “prices” SNB policy. Interest rate futures still point to a 60% chance of a 25bp hike by the end of the year, perhaps in sympathy with the ECB, which is signaling a hawkish tilt. Despite current ECB guidance on rate hikes (which we expect to change as the Eurozone economy slows), options markets still point to marginally lower EUR/CHF via risk-reversals."

"Whatever the SNB’s own messaging, which we see as internally consistent, rate markets and FX options continue to point in opposite directions. If the SNB were truly worried about inflation, especially from external supply factors, there would be much greater tolerance of currency strength rather than an “increased willingness” to intervene. Ultimately, it comes down to the conditional inflation forecasts."

"We would also keep an eye on the Swiss Population Cap referendum, as its passage will have material implications for Swiss–EU relations in the long term."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)