Saturday, January 17, 2015

Swiss Short-Term Currency Traders Offside

The recent removal of the Swiss franc (CHF) currency peg to euro by the Swiss National Bank caught many short term currency traders by surprise. Long term, our view remains unchanged as we believe the CHF will ultimate decline in value relative to the USD. Today, the CHF is currently 64% overvalued to the USD as measured by purchasing power parity.

Lesson learned in major currencies like the Swiss franc and currency pegs. Surprise currency interventions and policy changes can work against your trade in the very short term with extreme currency valuations as traders cover their shorts (those betting on a short term decline of the franc to the USD and the EUR). If you are a long term trader, purchasing power parity is a good measure to determine a currency value.

In the unique case of Switzerland, their is an inherent premium built into the  CHF value due to its historical lure as a safe haven currency. Further, currencies can remain in an overshoot or undershoot position much longer then most traders can stay solvent. If we assume a built in 25% purchasing power parity premium to the price of the CHF, then over the long term, their is a high probability that the CHF will ultimately decline relative to the USD back towards a 80 to 85 cent US fair value. If the currency undershoots, then 65 US to 70 US cents is possible. This could take years to achieve.

In the world of currencies, irrational market behaviour and illogical valuation can last for a very long time as perception / emotion and safe haven status premiums can artificially support an expensive currency valuation.

We prefer to take medium to long term positions rather then roll the dice in short-term currency moves thus mitigating risk from unforeseen policy decisions that can move a currency into a further illogical trading value.

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