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A glimpse at ECB policy normalization: 2017 began with the negative news that had been holding the euro back, melting away like winter snow.
The euro rallied earlier and rose faster than expected, culminating in a final spike higher when the ECB President brought up the idea of further tapering of bond purchases. Now, with the ECB committed to buying EUR 30bn per month until September, 10y Bund yields are 25bp below their July levels and the positive economic outlook is largely priced in. A sudden move higher for the euro, on the back of ECB moves, is therefore unlikely.
But even so, the pressure to normalize policy will remain in place, and the long-term prospect of investors being crowded back into euro-denominated assets will underpin the currency. The Swiss economy has overcome the appreciation shock. In Q3, it posted solid growth of 0.6% in the previous quarter and in October, the inflation rate climbed to its highest level since 2010 at 0.7%.
Nevertheless, we do not expect any change in monetary policy in the near future as the Swiss central bank still does not want to see a stronger CHF. We only expect the first SNB interest rate hike when the ECB has started to raise rates and the EUR-CHF exchange rate is above 1.20 again. This should be the case at the end of 2019 at the earliest.
Despite the SNB’s claim that the franc is overvalued, the Swiss current account surplus has been stable at an elevated level for several years. The US government has raised pressure on Switzerland over the persistent surplus and its foreign exchange interventions. Although Switzerland is not pursuing a weak currency policy, the persistent external surplus is a key counterpoint to any claim that the franc is overvalued.
Hedging framework:
Accordingly, we formulate suitable hedging framework contemplating all the above aspects. Place call ratio spread with 1:2 ratios.
How to execute: At spot reference: 1.1649, buy ITM (1.1480) +0.66 delta call with longer expiry (let’s say 2m tenor). Sell two lots of OTM strike calls (1.2065) of comparatively narrowed tenors (say 1m).
Thereby, we’ve formulated the strategy so as to sync ongoing technical trend with the bearish neutral risk reversals.
The delta value becomes more and more insensitive as the EURCHF falls lower and lower and hence on the lower side, the delta value is zero.
On the higher side, it increases in magnitude but remains negative indicating the negative effect on the options trader position with the pair rallying.
Why call ratio spread: The pair has been oscillating as you could observe in the rising channel pattern (made slumps and recovery), we see a neutral to the bullish environment when you are projecting decreasing volatility.
Currency Strength Index: FxWirePro's hourly EUR spot index is displaying shy above -36 levels (which is bearish). While hourly CHF spot index was inching towards -17 (neutral) while articulating (at 11:41 GMT). For more details on the index, please refer below weblink:
http://www.fxwirepro.com/currencyindex
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