USD/CHF 2006 Q4 Outlook

If you looked at the performance of the Swiss Franc in the third quarter of 2006, you would not be able to tell that the Swiss economy continued its rapid expansion in the third quarter with manufacturing, construction and foreign trade as the major driving forces.

USD/CHF Outlook

If you looked at the performance of the Swiss Franc in the third quarter of 2006, you would not be able to tell that the Swiss economy continued its rapid expansion in the third quarter with manufacturing, construction and foreign trade as the major driving forces. On September 14th, the Swiss National Bank raised rates by 25bps to a 3-month Libor mid-target rate of 1.75%. The central bank raised its growth forecast for 2006 from 2.5% to 3% and Roth, the SNB President, said the bank would continue to hike rates gradually if the economy develops as expected. Recent economic data has come in softer, but the levels still remain high and will keep the economy on the track for further growth.

Switzerland is the World's Most Competitive Economy

According to the latest Global Competitiveness Report released by the World Economic Forum, Switzerland is the world's most competitive economy in 2006, topping the US, UK, Japan and Germany. Although the rankings are based upon a broad array of factors including market efficiency, health care services, primary education and technological innovation, strong growth is certain to have a played a role in placing the country at its top ranking. The labor market continued to improve with the unemployment rate close to its lowest levels since October 2002. Still, the decline in unemployment was a little slower between April and August and the volume of work rose less rapidly than in the first quarter. Swiss foreign trade was slightly weaker than at the beginning of the year but the trend remains healthy. Exports rose moderately while imports dropped slightly. July's trade balance was the highest in over a year as demand from the European community helped to compensate the costs of fuel imports. Inflation eased more than expected in September declining to an annual rate of 0.8% after 1.5% in August, mostly due to falling prices for fuel and energy. The KOF leading indicator index slowed in both August and September, but it is coming off the cycle high of 2.48 that it hit in July. The index is still far above 2004 and 2005 levels. The same is true for the manufacturing PMI index. Although it dropped in August, the July reading also reached record high.

How far the SNB will go?

According to interest rate futures, the market is currently pricing in one more rate hike before the end of the year. SNB Vice President Blattner said that if the exchange rate depreciated too much this would lead to inflation fears which could put serious risks to the SNB's inflation forecast. With the franc trading at a 6 year low against the Euro and a five month low against the US dollar, the downward pressure on inflation caused by falling oil prices should be offset by the upward pressure caused by a depreciating currency. One more rate hike may indeed be all that the SNB has left to do since some members have already become less hawkish, fearing that the world economy may be turning a corner and may slow into 2007 and 2008. The SNB statement given to the press following the last interest rates decision was also less hawkish than the market expected, with downward revisions to inflation over the next two years. The inflation forecasts were revised down to 1.1% in 2007 and 1.6% in 2008 accounting for the effect on inflation of more moderate growth.

EUR/CHF at Six Year Highs

The EUR/CHF currency pair has really been on the move since the beginning of the third quarter. This is a currency to watch since the higher it runs the more beneficial it will be the Swiss economy. The country does a great deal of trade within the Eurozone which means that a weak franc will help to boost exports. However flows have driven the rise of EUR/CHF even though positive Swiss fundamentals call for more strength. Unfortunately, with the future monetary policy of Switzerland mostly priced into the market and the risk for further ECB rate hikes not completely discounted, the risk is still for more gains in EUR/CHF as interest rate differentials continue to widen in favor of the Euro.

Shift from Safe heaven currency to carry trade victim

Historically the Swiss franc has been considered a safe haven currency fully backed by gold reserves but that's not longer the truth. Following an amendment to the Swiss Constitution on 1 May 2000 the Swiss government decided to sell most of its inventories and the currency lost its positive correlation with gold. Although, the banking sector in Switzerland is highly trusted and remains one of the world's best, the country seems to have fallen behind on the preferences of people who want to make deposits or investments during times of geopolitical uncertain. The Swiss Franc has not reacted at all to the recent nuclear test in North Korea. If anything, it continued to slide. At the same time, carry trades have returned with a vengeance, with the Franc punished harshly as traders short the low carry currency to fund purchases of high carry ones. Carry trades are much more dangerous these days than in the past as both Switzerland and Japan are looking to increase interest rates in the months to come.

Conclusion

Strong corporate demand for commodities and primary products suggests growth in Switzerland should remain above trend and inflationary pressures are likely to press the SNB to hike rates by 25bps at the December 14 meeting. In the last SNB Monetary Policy Report, delegates for regional economic relations expressed great optimism with regard to the current economic situation and have signaled that another rate hike is likely. Although data has shown slight signs of weakness, the growth levels are coming off extremely high points. The sell-off in the Swiss Franc should continue to come to the aid of the economy and give the central bank greater confidence to raise interest rates. However, in 2007 growth is likely to fall back towards potential growth and it's the data that will determine both the pace of the SNB tightening and the strength of the Swiss franc.

Technical Outlook

Similar to other majors, USD/CHF has room left to retrace the large dollar bear trend that took place from October 2000 to December 2004. Viewing the 5 wave uptrend from 1.1283 (December 2004) to 1.3284 (November 2005) as the first of 3 corrective waves means that the previous slide from 1.3284 to 1.1919 (5/19 low) is the second corrective wave. Thus, we should expect an advance similar to that of the first corrective wave from 1.1283 to 1.3284. After crunching the numbers, we find that the rally from 1.1919 could extend all the way up to 1.3920 (1.1919 + (1.3284 -1.1283) = 1.3920). This level is critical. Not only is it an Elliott calculation, but also not far from the 38.2% fibo of the 1.8300-1.1283 October 2000 to December 2004 bear wave. The 1.3920/63 opinion is a bit longer term, but the recent break of the 9/15 high at 1.2622 lends credence to a longer term bullish outlook. Weekly studies are bullish – positive MACD slope, RSI above 50 and USDCHF closed above the 40 week SMA during the week that ended 10/6/2006. The slope of the 40 week SMA has turned positive for the first time since June 2005. Also, an inverse head and shoulders pattern that began in January 2004 favors bulls. Former resistance at 1.2622 is now support. Price needs to remain above the 8/22 low at 1.2182 in order to keep the bullish structure intact.

USDCHF Weekly Chart (Source: FXTrek Intellicharts)

USD/CHF Positioning

Sentiment is negative as speculators are short CHF futures. However, positioning is not yet extreme. This favors continued CHF weakness (USDCHF strength).

DailyFX

Disclaimer

Investment in the currency exchange is highly speculative and should only be done with risk capital. Prices rise and fall and past performance is no assurance of future performance. This website is an information site only. Accordingly we make no warranties or guarantees in respect of the content. The publications herein do not take into account the investment objectives, financial situation or particular needs of any particular person. Investors should obtain individual financial advice based on their own particular circumstances before making an investment decision on the basis of the recommendations in this website. While we try to ensure that all of the information provided on this website is kept up-to-date and accurate we accept no responsibility for any use made of the information provided. All intellectual property rights are the property of Daily FX. Daily FX and its affiliates, will not be held responsible for the reliability or accuracy of the information available on this site. The content herein is provided in good faith and believed to be accurate, however, there are no explicit or implicit warranties of accuracy or timeliness made by Daily FX or its affiliates. The reader agrees not to hold Daily FX or any of its affiliates liable for decisions that are based on information from this website. Daily FX highly recommends that before making a decision, the reader collects several opinions related to the decision and verifies facts from at least several independent sources.