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We diffidently concluded that a widening in interest rate differentials, on USDCHF if not EURCHF a few months ago, and was exerting a more powerful influence on capital flows than we had expected.
But for now, the Fed hiked key rates yesterday conforming to the common consensus. The target range for the federal funds rate now is at 1.75%-2.00%. Policymakers no longer expect that key rates will for some time remain below their normal levels. Starting in January, Fed chair Powell will hold a press conference after every FOMC meeting.
Quite a lot has changed since our last post on CHF crosses, however, and this month we are lifting the franc again due to the Italian crisis and the attendant downgrade to our EURUSD forecasts. The 1Y EURCHF projection is lowered from 1.19 to 1.17, the end-2018 is cut from 1.19 to 1.16. The 1Y USDCHF forecast is tweaked from 0.94 to 0.95.
As such, while we continued to characterize CHF as a structurally robust currency, backed by a near-record basic balance surplus (12% of GDP) and neutral long-term valuations, we lowered our forecasts for the franc in April.
While we emphasize on zero-cost GBP put/CHF call vs. USD put/CHF call switch: Our macro G10 FX portfolio is positioned short GBPCHF, a directional view that marries deteriorating UK cyclicals and Brexit unease with any potential upside from CHF appreciation resulting due to weaker equity markets and/or more forceful discounting of SNB policy normalization by rate markets now that the franc is no longer overvalued.
The motivation for mulling an option based expression of the view is that GBPCHF implied vols have been crushed by not only a broad compression of FX risk premia but also an increase in GBP vs. CHF via USD correlations towards historic highs over the past few months of dollar-centric price action in currency markets. Realized vols are also performing at par with or even slightly better than short-dated implied vols, which had motivated a long GBPCHF vs short USDCHF spread suggestion last week.
The choice of USDCHF as the funding leg of that RV is as important as long GBPCHF since realized vols in the pair have consistently disappointed and risk-reversals have been over-priced for USD puts for a while as an artifact of the market’s long memory of the franc de-peg. A directional variant of this vol RV that can better suit many macro portfolios not given to active delta management is a zero-cost long GBP put/CHF call vs. short USD put/CHF call option switch (live options, not delta-hedged).
Conceptually, such a spread expresses a short GBPUSD delta view; premium-neutral switches using identical tenor and moneyness strikes on both legs are possible by,
a) The lower vol base on the GBPCHF leg;
b) The still extant bid for USD puts on the USDCHF skew, and
c) Most importantly, wider forward points on USDCHF after the 60bp+ rise in Treasury yields this year.
For instance, long 3M 2% OTMS GBP put/CHF call vs. short 3M 2% OTMS USD put/CHF call switch, equal CHF notionals on both legs is costless. For comparison, the corresponding 3M 2% OTMS GBP put/USD call equivalent costs 64bp (mid). Courtesy: JPM
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