The Swiss franc (CHF) is well known as the ‘world’s second currency‘. However, with the recent announcement that the Swiss National Bank will be changing the exchange rates of its currency against the Euro, some are worried that the Swiss economy might suffer the same fate as its European counterparts. Will the Swiss government to reverse its recent decision to put the CHF on a path towards fixed rates? What are the implications of this decision for traders? Are the Swiss government’s motives related to maintaining economic stability or trying to boost economic growth through the strength of the CHF? The answers to these questions are likely to emerge over the coming weeks and months.
One of the reasons why traders believe that Swiss monetary policy is aimed at stabilizing the Swiss economy lies in the fact that the Swiss National Bank has been keeping its interest rates on hold since early May this year, despite continued signs of weakening Swiss economic performance. The Swiss National Bank believes that its current intervention measures are appropriate and have achieved their objectives. In other words, the Swiss government believes that intervention has done enough to prevent a possible rise in inflation, which would result in the Swiss economy contracting further. In addition, the Swiss government argues that its recent interventions have stopped the global interest rate trend from going south, thus preventing a possible global economic crisis. The Swiss government claims that these policies are meant to support its national currency, the Swiss Franc, rather than the euro as many critics claim.
The Swiss government’s fears seem to be justified. Recent studies show that Switzerland is the only developed country to experience negative growth in the face of a global recession. Meanwhile, the euro has lost ground against the Japanese yen, which has lost significantly against the euro over the past year. In addition, the Swiss government is worried that the euro will continue to weaken against the Swiss dollar, which would result in a major Swiss currency trade deficit with Europe. These fears have increased European doubts about whether Swiss monetary policy is effective.
Many investors who are speculating about the Swiss national interest rate and the Swiss economy base their expectations on the Swiss Franc. If the Swiss National Bank ends its policy of holding interest rates on hold, investors would execute a sell/buy transaction on the Swiss Franc/Dollars and US dollar pair immediately, resulting in sharp appreciation of the Swiss Franc and Swiss Dollar. In other words.. dollars in the expectation that it will depreciate against the euro.
Why would investors execute a sell-buy transaction on the Swiss Franc/Dollars when they have a very strong appreciation against the euro. The answer is simple. The EUR/SCHF currently trades at a higher premium to the euro and many traders have realized this and are positioning their trades accordingly. Since most of their trades are executed on the interbank market, there is very low liquidity in the euro swap market and the premium is high. This forces traders to execute trades on Swiss Franc/Dollars and US Dollar pair even if the exchange rate is going against the euro.
Investors who are positioning their trades based on the Swiss National Bank’s hints that the Swiss National Bank will reduce its interest rates should be executing a sell-buy transaction on the EUR/USD pair or vice versa. The euro has started to consolidate itself against the dollar and many investors believe that the euro will continue to rise versus the dollar. In addition, many traders who are positioned in the EUR/USD are expecting the euro to appreciate versus the euro against the dollar in the future.
Why is the Swiss National Bank hinting to its citizens that it might reduce the interest rates? The explanation is quite interesting and has much to do with the fact that the Swiss National Bank has many foreign assets and is seeking to secure them. It is acting in response to the current deficit which the euro has been causing in the past and which is causing problems for the Swiss National Bank. The government of Switzerland has been trying to solve the deficit by selling gold and buying other foreign securities. These moves are meant to stop the capital outflow that is being caused by the Swiss National Bank.
This action by the Swiss National Bank is similar to what the European Central Bank is doing right now when it is trying to keep the euro from strengthening too much. Many people have speculated that the EUR/USD may soon become the prefect target in the trading pairs. In order for you to trade the euro correctly, you need to know what the gDP of each of the four major countries is doing. If you are able to get this information, you will be able to determine when the time to enter or exit the marketplace is for your profit.