If Euro Dies, Franc Will Rise

June 14, 2012

A few weeks ago, we all looked in awe as the 10-year U.S. Treasury yields sank to a record low. You won’t be as awed once you see what’s going on in Switzerland.

As the tragic circus in Europe continues, investors have been piling into safe-haven assets, and one of the most popular has been U.S. sovereign debt.

However, as Zero Hedge noted this week, the Swiss, without question, have become the dominant force when it comes to safe-haven assets.


Sovereign Yield Curves


The Swiss one- to five-year yield curve now resides in negative territory, making German and French yields look quite attractive.

Here’s what’s going on. As the European crisis continues, investors are increasingly converting their euros into Swiss francs, and at an accelerating pace.

They’re then using those francs to purchase more Swiss debt, forcing yields into negative territory.

The true beauty in all this is that as the Swiss government issues more debt at these negative rates, it now essentially owes less than it initially borrowed.

But all is not well for the Swiss government.

In the fall of 2011, the Swiss National Bank pegged the franc to the euro in an effort to help Swiss exporters that were being hurt by the franc’s rally.

At the time, I blogged about how much pegging the franc to the euro would hurt Swiss-related investments.

Since the peg, the franc has fallen more than 20 percent against the U.S. dollar, via the euro’s slide versus the greenback.

The CurrencyShares Swiss Franc Trust (NYSEArca: FXF) has taken quite a beating, and the iShares MSCI Switzerland Index Fund (NYSEArca: EWL) has suffered from the franc’s depreciation as well.

How Low Can The Franc Truly Go?

As many debate whether the euro will exist in its current form in the future, one thing is clear: The Swiss National Bank is doing everything in its power to keep the peg. The SNB continues to buy large amounts of euros while selling the franc in order to defend the cap.

Unfortunately, the writing is on the wall.

As the euro continues its downward trend, it’s becoming increasingly difficult for the Swiss central bank to stick to the task. As recently as April this year, the peg was breached. If anything, the Swiss yield curve is a clear sign that demand for the franc is only getting stronger.

This Sunday, June 17, Switzerland’s policy will be tested again.

If the Greek elections fail to convince investors that Greece is prepared for austerity measures—or, worse, set the stage for Greece to abandon the euro—expect the eurozone’s currency to go into something of a free fall.

Things don’t look promising. Days before the polling, Greeks are pulling their cash out of banks and stocking up on food in fear of what may result.

Should a “Grexit” come to pass, not only will the euro see new lows, but more than likely the franc’s peg will be broken.

Some online brokerages are already hiking up margin requirements on those that have made bearish bets against the franc.

But frankly, I think it’s time to head in the other direction.

ETF investors would do well not only in managing their European exposure prior to this Sunday, but also looking at FXF as a potential buying opportunity.

The Swiss National Bank has engaged in a risky currency play that it probably won’t be able to keep much longer.

We can only hope for the best, but at least thoughtful investors may have some potential upside in the game.


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