A weaker Swiss franc could be an unexpected consequence of recent rare U.S.-Japanese intervention to prop up the yen, bringing relief to companies and policymakers in Switzerland who have grappled with the strength of their local currency for years.
The franc is still 12% stronger against the euro than five years ago, despite some recent softening, thanks to Switzerland's persistent current account surplus, sound public finances, low inflation and safe-haven inflows. Its strength has made the country's exports more expensive and squeezed economic growth.
Both the yen and the franc are influenced by the FX carry trade and weaken when investors borrow in these currencies with low interest rates to sell them and buy higher yielding assets elsewhere, often emerging markets.
The yen has long been the funding currency of choice but it is expected to remain jumpy with traders alert to further intervention risk. That has prompted the start of a rotation to the Swiss franc, say analysts and investors, a trend that will likely continue if Washington and Tokyo are able to engineer a stronger Japanese currency.
"Market participants will be thinking about rotating some of their funding positions," said Fredrik Repton, senior portfolio manager with the global fixed income and currency management teams at Neuberger Berman.
"If you look at the performance of euro-Swiss, that's probably more instructive to how the market environment has been shaping up."
At around 0.9385, the franc is near its weakest in around a year against the euro , having softened about 4% from March's 11-year peak near 0.9. It is also down nearly 7% from an 11-year high hit versus the dollar in January .
Rabobank last week revised up its 9- to 12-month target for euro/Swiss franc to 0.95 from 0.94, reflecting expectations the franc will weaken further.
THE FX CARRY TRADE IS CHANGING
Carry trades are having their best run in years, boosted by low FX volatility. But they become more challenging when a currency starts to swing, wiping out the small profit from rate differentials.
Analysts say it is hard to pin down the size of the carry trade, but point to currency short positions, essentially bets on an asset weakening, as a good proxy.
The recent intervention has prompted an unwinding of yen short positions, pushing the outstanding number closer to those in the franc.
"It's going to take a lot to shift away from the yen as a funding currency, but there is a lot out there to shake people out of that habit," said ING's global head of markets Chris Turner.
Although the yen is expected to remain a popular carry trade choice as one of the most actively traded major currencies, intervention risk is just one factor making investors think twice about betting against it.
Japanese rate-hike expectations and speculation that Japan's giant Government Pension Investment Fund could shift allocations towards domestic investments are also shifting yen dynamics.
With borrowing costs pinned down by the Swiss National Bank, the franc stands out as an obvious carry trade alternative to the Japanese currency.
"Not only are Swiss rates lower than the Japanese yen, but (franc) volatility is lower as well," said BofA's head of global G10 FX strategy Adarsh Sinha.
Swiss rates are currently 0% and Japanese rates are 1%.
BofA has a long-standing recommendation to sell the Swiss franc against the yen targeting 190 yen per franc, from 196 yen currently and 200 before the recent intervention.
The recommendation is partly due to Japan's stabilising balance of payments but also supported by the fact that funding in Swiss francs looks more attractive than with the yen, Sinha said.
Any weakening of the franc under a shift to using it to fund carry trades would be welcomed by the SNB, which has said it would intervene if necessary to weaken the currency.
Neuberger's Repton said he wasn't as negative on the Swiss currency as he was two months ago given recent sharp moves, although he continued to "dislike" it.
ING's Turner said a shift to using the franc as a funding currency instead of the yen still appeared to be in the early stages, but could well take place.
"The Japanese want a stronger yen, the Swiss want a weaker franc, so it would make sense."
