Swiss Franc Gains Popularity as Funding Currency for Carry Trades, Potential for Rapid Rallies - Harry Robertson
Investors are turning to the Swiss franc as an alternative to the Japanese yen for carry trades, increasing the risk of the currency experiencing sudden rallies. The Swiss franc has been a popular choice for traders looking to borrow currencies with low interest rates and invest in higher-yielding assets.
The appeal of the Swiss franc has grown as the yen's popularity has waned. Yen carry trades suffered in August due to a strong rally in the currency following weak U.S. economic data and a surprise rate hike by the Bank of Japan. The Swiss National Bank's easing cycle earlier this year has positioned the Swiss franc as an attractive funding currency, with its key interest rate at 1.25%.
Compared to other major economies, interest rates in the United States, Britain, and the eurozone are significantly higher, making the Swiss franc an appealing choice for carry trades. Analysts expect a gradual decline in the Swiss franc's value, potentially increasing returns for investors engaging in carry trades.
Speculators currently hold a significant short position against the Swiss franc, indicating its use in funding carry trades. Banks like Bank of America and Goldman Sachs recommend buying sterling against the franc due to the interest rate gap between Switzerland and Britain.
The SNB is likely to cut rates further in the coming months to combat dwindling inflation, which could lower borrowing costs for the franc and weaken the currency. Central bankers are wary of the Swiss franc strengthening further, as it can harm exporters and the overall economy.
However, the Swiss franc carries inherent risks, particularly during times of market volatility. Investors tend to flock to the currency in times of uncertainty due to its safe-haven status, which can lead to rapid rallies and losses for carry trade positions. The SNB may intervene to prevent excessive currency appreciation.
In conclusion, investors should be cautious when using the Swiss franc as a funding currency for carry trades, considering the risks involved during periods of market turmoil. Understanding the dynamics of currency markets and central bank actions is crucial for making informed investment decisions.