Citibank: Going long EUR/CHF

From Citibank’s NY strategist Donnelly:

I would guess there is some discomfort in the offices of the SNB right now as Europe has loaded up its QE cannon and is ready to fire the next shot in the currency wars. EURCHF is taking collateral damage, an innocent bystander caught in the crossfire. The market has quickly priced in some sort of action at the September ECB meeting (depo cut, ABS buying, maybe QE?) and most European rates are negative out to the 2-year point. Short bonds and earn the carry—amazing!! As you can see in the little chart on the right, 5-year Germany/Switzerland spreads have been tracking EURCHF very closely and if the SNB wants to keep EURCHF off 1.2000, they need to do something soon. We just dropped from 1.2170 to 1.2070 in 22 days. Extrapolating that rate of decline, we will be on the floor before the end of September.

The SNB is not afraid to take bold action as you can see in Chart1. I think it’s worth going long EURCHF here with a stop at 1.2044. It is a bit of a confusing trade as it seems odd to stop out at 1.2044 when the floor is at 1.2000 but vol is so low that I don’t think it’s worth holding all the way down. I would rather take a more levered position here and just bail if 1.2044 trades. You might prefer to just hold it all the way down to the floor and that is reasonable too but the risk of doing that is that you get into a position that you end up holding for months and months because if we get to the peg it could just sit there 1.2010/12 for weeks and weeks like it did last time. Have a frank day.

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