Analysis-Swiss franc carrier traffic fraught with safe-haven growth risks By Reuters

By Harry Robertson

LONDON (Reuters) – As investors turn to the Swiss franc as an alternative to the Japanese yen to fund carry trades, the risk that the currency could make one of its rapid rallies remains ever-present.

The Swiss franc has long been used in the popular strategy where traders borrow currencies at low interest rates, then exchange them for higher-yielding assets.

Its appeal intensified even more as the yen weakened. Trading in the yen exploded in August after the currency rallied sharply on weak US economic data and a surprise rate hike by the Bank of Japan, helping to trigger global market turmoil.

The Swiss National Bank (SNB) was the first major central bank to start an easing cycle earlier this year, and the main interest rate is 1.25%, allowing investors to borrow francs cheaply to invest elsewhere.

By comparison, interest rates are between 5.25%-5.50% in the United States, 5% in the UK and 3.75% in the Eurozone.

“The Swiss franc is back as a funding currency,” said Benjamin Dubois, global head of overlay management at Edmond de Rothschild Asset Management Suisse.

STABILITY

The franc is near an eight-month high against the dollar and a nine-year high against the euro, reflecting its safe-haven status and expectations of European and US interest rate cuts.

But investors are hoping for a gradual decline in the currency’s value, which could boost returns on carry trades.

Speculators kept a $3.8 billion short position against the Swiss franc, even as they suddenly moved to a $2 billion long position on the yen, data from the U.S. Commodity Futures Trading Commission showed.

Analysts typically see a large short position as a sign that a coin is being used to fund carry trades.

“There is now more two-way risk in the yen than there has been for some time,” said Kamal Sharma, senior G10 FX strategist at Bank of America. “Swiss Franc Shows More Logical Funding Currency of Choice”.

BofA is advising investors to buy sterling against the franc, arguing that sterling may rise due to wide interest rate differentials between Switzerland and Britain, in a call echoed by Goldman Sachs.

The SNB looks set to cut interest rates further in the coming months as inflation eases. This would reduce borrowing costs in francs and could affect the currency, making it cheaper to pay back those who already borrow it.

Central bankers also appear reluctant to see the currency strengthen further, partly because of the pain it could cause exporters. BofA and Goldman Sachs say they believe the SNB stepped in to weaken the currency in August.

“The SNB will likely protect against currency appreciation by intervening or cutting rates as needed,” said Michael Cahill, Goldman’s G10 currency strategist.

“INHERENTLY RISKFUL”

However, as it is known in the forex markets, it can be an unreliable friend.

Investors tend to get into the currency when they get nervous because of its long-standing reputation as a safe haven.

Cahill said the franc is best used as a funding currency at times when investors are feeling bullish.

A rapid rise in the currency used to fund carry trades can wipe out gains and prompt investors to quickly unwind their positions, as the yen drama has shown. High levels of volatility or a decline in the higher yielding currency can have the same effect.

The SNB and Swiss regulator Finma declined to comment when asked by Reuters about the impact of the carry trades on the Swiss currency.

As stocks fell in early August, the Swiss franc rose as much as 3.5% in two days. The franc-dollar pair has proven sensitive to the US economy, often acting strongly on weak data that causes US Treasury yields to fall.

“Any carry trade is inherently risky and this is especially true for those funded with safe-haven currencies,” said Michael Puempel, FX strategist at Deutsche Bank.

“The main risk is that when yields shrink in a risk-free environment, yield spreads compress and the Swiss franc may recover,” Puempel added.

A measure of how much investors expect the Swiss currency to move, derived from options prices, is currently at its highest level since March 2023.

“Given the central banks, you can see how there could be greater sentiment for some carry players who prefer the franc to the yen,” said Nathan Vurgest, head of trading at Record Currency Management.

“The ultimate success of this carry trade may still depend on how quickly it can be closed in a risk-free scenario,” Vurgest said, referring to a time when investors reduce their riskier trades to focus on cash protection.