Swiss Franc Surge Seen on Brexit, SNB to Keep Powder Dry Incase of Such an Eventuality

The CHF is in demand as investors seek the currency for its safe-haven attributes ahead of the UK’s EU vote. This demand will only increase in the event of Brexit.

The headache posed by the EU referendum has spread far beyond Britain's shores to the cantons of Switzerland whose central bankers will be preparing potential policy responses to a Leave vote. 

Hedge demand for the Swiss franc (CHF) has already driven the currency's value to increasingly overvalued levels thanks to it being a popular hedge used by investors to protect against Brexit.

Those with an exposure to the pound and UK economy could hedge against potential losses by buying Swiss francs.

HSBC’s global head of research, David Bloom, is one analyst who has recommended going long the Swiss franc as the ideal hedge in case of the sterling weakening following a Brexit vote.

According to Bloom the pound is at risk of falling 15-20% against the dollar in the event of the UK voting to leave the EU.

Bloom argues the Franc makes the perfect instrument for hedging against a depreciation in the pound, because of its “asymmetrical” nature.

“The use of the CHF as a hedge against Brexit is gaining in popularity. Since the beginning of June, the CHF has gained nearly 2.5% against the EUR, indicating the extreme buying pressure exhibited on the Swissie,” says Peter Rosenstreich at Swissquote Forex Services.

The strengthening franc will not be welcomed by the SNB who see the rising currency as an impedement to economic activity in the country. 

The SNB are due to meet this Thursday and will issue their quarterly policy assessment, which will include new growth and inflation forecasts.

The policy release will then be followed by a briefing by SNB president Thomas Jordan, as well as SNB members Zurbruegg and Maecher. With regards to policy we do not expect any changes.

The deposit rate will be kept at its historical low of -0.75% and its target for three-month franc Libor held at between -0.25% percent and -1.25%.

Swissquote expect the SNB is likely to move extremely cautiously heading into the EU referendum, in order to maintain a reactive stance.

"Jordon is expected to reiterate that the franc is “significantly overvalued” and that the SNB will ‘intervene if necessary.’ Despite evidence that the SNB is already intervening in the FX markets, showing scant tolerance for CHF strength," says Rosenstreich.

However, it is pointed out that the Swiss National Bank could be reaching the limit of the actions it can take to control the franc.

While general support for the SNB policy remains, expansion of the balance sheet (now above 95% of yearly GDP) will likely make people anxious.

Remember, it was not so long ago that a Swiss canton attempted to rein in the SNB with a gold referendum.

“We anticipate that a Brexit would have profound collateral effects on the CHF. The SNB’s first line of defence will be direct FX intervention,” says Rosenstreich.

But, given the level of balance sheet expansion needed to support the 1.20 floor against the euro, there is a clear credibility risk, with the SNB providing tough rhetoric but backed by limited firepower.

Second tier defense such as tightening on negative interest rate exemptions and more negative interest rates are still on the table but will take longer to become effective.

“Should the UK vote to Leave, we anticipate a stampede into CHF, which the SNB is ill equipped to handle. We remain long CHF against the USD and EUR heading into the Fed monetary policy meeting and the EU referendum,” says Rosenstreich.

Morgan Stanley see CHF in Demand Regardless

The problem for Swiss authorities is that the franc is likely to remain attactive, whatever the market mood.

In a client note this week, Morgan Stanley have said they view CHF as attractive in times of risk-on and risk-off market conditions.

"With a large part of its yield curve in negative territory, CHF's nominal yields have low elasticity to the downside, contributing to rising real yields supporting the currency strength even when risk is supported. If risk sells off, CHF tends to appreciate given its safe haven status. It is also likely to receive additional support from the European risk events this month," say Morgan Stanley.

UBS Confirms Continuation of Massive Flows Into CHF

To highlight just how 'in demand' the franc is, UBS have confirmed that their currency flow data shows the CHF was net bought for a tenth consecutive week.

"Last week's directionality extends again; CHF, JPY, AUD bought; USD, NOK sold Recent trends in G10 flows largely continued," says Jeremy Chandler at UBS.

The USD was net sold once again last week, despite a slight rally in the DXY index.

"The greenback has now seen outflows for six consecutive weeks, its second-longest streak of outflows since our records began in 2001. The CHF was net bought for a tenth week in a row, on a week when EURCHF sold off 2%," says Chandler.