Fundamental Outlook for Swiss Franc: Bearish

- A steep drop in the carry trade has weighed on the franc crosses but not USDCHF
- Interest rates speculation has held steady, but the ECB and SNB may change that

The Swiss franc has had a mixed reaction to its major counterparts this past week. For those pairs with obvious carry potential, speculation over the health of the international financial markets has lead to spectacular volatility. On the other hand, the USDCHF major is still stuck in the dollar’s steady, gravitational field; and the pair has certainly not retraced as much as some of its counterparts (like the euro and pound denominated pairs). Looking out over the trading week ahead, yield speculation and swings in risk appetite will only increase with the SNB scheduled to announce rates and a number of banks teetering on the brink. Could this event risk finally topple the USDCHF’s persistent trend?

When liquidity first returns to the market, franc traders’ immediate concern will be the health of the financial sector. The Lehman Brothers’ sale presents the greatest probability for altering the health of risk trends and thereby the carry trade. Much has been said about the regal firm searching out potential suitors and looking for help from the Fed, but little has been confirmed. However, this is the same way the Freddie/Fannie sale (and Bear Stearns before that) progressed. A weekend sale would be good for the carry trade (which depends on low volatility and wide yield differentials). And, while there is little such interest in the USDCHF (as the franc actually has a higher yield than the dollar), the benefit of relief to the US banking sector and general franc selling may lead the pair higher. However, any tranquility that comes out of such a deal wouldn’t last long. Besides Lehman, Washington Mutual is said to be in need of a buyer, AIG has suggested it may go on sale, and countless other firms are looking at further write downs and lost revenues. With banks failing at their fastest pace in 14 years and the Fed’ ‘watch list’ growing, it will only be a matter of time before the market has to speculate on the next collapse.

Aside from the ever present danger seen the swells of risk appetite and aversion, traders will also be taking in the Swiss National Bank’s monetary policy decision on Thursday. The steady paced Swiss bankers are expected to keep the benchmark lending rate at 2.75 percent; but the forecast is up for grabs. Though the group convenes (usually) only once every three months, their forecasts typically offer a lot to work with. No doubt, President Jean-Pierre Roth and his fellow rate setters will reflect on weakening growth, ongoing credit concerns and perhaps offer a soft inflation outlook. Essentially the ingredients for a rate cut in the coming quarters. If this is the case, the franc could sell off as it’s funding currency status steps up a notch.

Antonio Sousa is a Currency Analyst for FXCM.