FxWirePro: Relative Value Trades for New Year carnival – EUR/CHF to fund USD/SEK Option Hedge

In this write-up, we emphasize relative value possibilities. We encourage EURCHF shorts in spot trades, partially to hedge a medium-term options shorts in USDSEK.

EURCHF is a realistic proxy for a tactical short in EURUSD given that the two pairs have been 85% correlated over the past three years. Whereas the scepticism about this noticeable connexion is at risk of breaking down should EURUSD ever spike off assertively, EURCHF is suspected to continue to closely track EURUSD whenever the euro is under pressure. 

This all comes down to Switzerland’s superlative external position and the possibility that the SNB has reached or is closer to the limits of its ability to intervene to frustrate a fundamentally justified appreciation in CHF. 

The SNB has recycled virtually all of Switzerland’s current account surplus for a decade (contrast this with the BoJ which has done none), yet the SNB’s ability maintain this policy in a shakier asset market environment is questionable with the balance sheet at 122% of GDP and provisions sufficient to cover only a 17% asset write-down (i.e. the SNB is effectively 5.3x levered). The SNB has notably omitted to intervene since the spring despite the Italian crisis and it can be no surprise therefore that the CHF NEER is 6% higher than the trough in May. 

The big dollar turn is argued in the recent times that was not yet imminent. Nevertheless, the base case for 2019 does envisage a handover from US to Euro area growth and mean-reversion in undervalued European FX. SEK screens as the cheapest European currency (REER 14% below 20Y average) and also has a central bank that is poised to slowly reverse its multi-year experiment with super easy monetary policy. We consequently added a medium-term put spread in USDSEK, but structured it as a 1-1.5x to lower the cost as we lacked conviction that the trade was yet poised to work. We weren’t wrong in that judgement; it obviously remains to be seen whether EUR and SEK can turn things around against the dollar by the middle of 2019.

Trade tips: 

Short EURCHF at 1.1244 with a stop at 1.1469 levels.

Long a 6M 8.55 - 8.15 USDSEK ratio put spread in 1x1.5 notional. Paid 76bp in November. Marked at 46bp. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly EUR spot index is inching towards -37 levels (which is bearish), while hourly USD spot index was at 37 (mildly bullish), CHF is at -0 (neutral), while articulating (at 14:36 GMT). 

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex