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The underperformance of Swiss franc (CHF) through mid-April was partially driven by market expectations of an eventually benign outcome on global growth on the back of global policy easing which also culminated into FX volatility grinding to the low-end of its decade-long range.
The nascent global growth recovery and the low-vol is regime is now once again being threatened by a re-emergence of a more aggressive US trade policy. While the conditions remain fluid and US-China trade negotiations are still ongoing, a further escalation of the conflict is not likely to bode well for high beta FX and on the contrary, is likely to be supportive for defensive currencies such as CHF given our view that FX markets are currently priced to more optimistic growth outcomes.
CHF is unlikely to be immune from an escalation of trade conflict which spills into broader risk sentiment. In such an event, the channel of transmission is likely to be the market readjusting to lower growth outcomes and pricing in more risk premia for tail risks. Recall that last year, CHF was among the best performing currencies globally amid the softer growth backdrop and escalating tail risks. While CHF has been less sensitive to changes in risk sentiment (as measured by equities) in comparison to say USD or JPY, CHF (negative) sensitivity to equity markets is the nonetheless the third largest globally (refer 1stchart). The beta has been stable for the past year but has shown signs of increasing in magnitude when the market volatility increases (refer 2nd chart).
6m IV skews of USDCHF are stretched for downside risks (noticeable bids for OTM puts are having higher demand), which means hedgers’ sentiments are positioned for bearish risks.
Positively skewed IVs (implied volatilities are the difference between OTM calls and OTM puts).
To substantiate this bearish stance, although we see some positive shift in risk reversals, negative risk reversal numbers remain intact that signifies hedging outlook for bearish risk sentiments. Courtesy: Sentrix, Saxo & JPM
Currency Strength Index: FxWirePro's hourly USD spot index is flashing 28 (which is mildly bullish), while hourly CHF spot index was at 73 (bullish) while articulating (at 08:38 GMT).
For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex
