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Franc Rises to World’s Most Expensive Currency as Taylor Sees Euro Parity

Date: Friday, July 22, 2011
Author: Lukanyo Mnyanda and Liz Capo McCormick, Bloomberg.com

Even after making the Swiss franc the most over-valued major currency, traders are betting on more strength as the European Union’s sovereign-debt crisis begins to infect bigger economies.

The franc rose to a record today against the dollar, euro and pound as bond yields in Italy and Spain surged to euro- lifetime highs. The cost to hedge a drop in the euro versus the franc climbed to the most since January 2009, signaling concern the EU may fail to contain a crisis that has already forced Greece, Portugal and Ireland to seek financial bailouts.

While the Swiss National Bank highlighted its ability last week to resume sales of the currency to stem gains that threaten overseas sales at companies including ABB Ltd. (ABBN), traders are pushing the franc higher. Strategists boosted their fourth- quarter median forecasts for the franc against the dollar by the most of 51 pairs tracked by Bloomberg.

“The Swiss franc looks like it will go to par with the euro,” said John Taylor, founder of FX Concepts LLC in New York, the world’s largest currency hedge fund. “The EU is not working on a real solution, just patches that only work for a certain amount of time. The franc will have the problem in the long run of money flowing into the country.”

Taylor, whose firm manages $8 billion, said he has trades that would profit from gains in the franc against the euro.

Trade, Unemployment

The franc is a favorite of traders because Switzerland has a current-account surplus, the broadest measures of trade, meaning it doesn’t need to rely on foreign capital to fund a trade deficit like the U.S. The nation’s 3 percent unemployment rate compares with 9.9 percent in the 17-member euro zone, and the economy is benefitting from its proximity to Germany, which buys about 20 percent of Swiss exports.

“The franc will remain a strong currency for a very long time because the credit crisis in Europe isn’t going away anytime soon,” said Sebastien Galy, a senior foreign-exchange strategist at Societe Generale SA in London. “We are in a global crisis of growth and in that environment balance sheets that are clean are appealing. That’s the case with Switzerland.”

The franc strengthened to a record 1.1374 per euro today and was at 1.14819 as of 10:53 a.m. in New York. It advanced to an all-time high of 80.33 centimes per dollar. It surged to 1.2979 per pound after Moody’s Investors Service cut the credit ratings of Portugal and Ireland to below investment grade and Fitch Ratings lowered Greece further into junk.

Correlation Indexes

It’s the best-performing currency against nine developed- market peers in the past year, rising 17 percent, according to Bloomberg Correlation-Weighted Indexes. Australia’s dollar is next best, advancing 10 percent.

Because of its trade ties, investors in the franc can participate in German growth without being penalized by the euro region’s weakest members. Switzerland’s economy may expand by 2.4 percent this year, compared with 3.4 percent for Germany, Bloomberg surveys of economists show. A separate poll shows that the euro zone may grow 2 percent.

The franc’s strength has helped contain inflation, enabling the SNB to keep its benchmark interest rate near zero. The European Central Bank raised its main rate twice this year, to 1.50 percent. Swiss consumer prices increased 0.6 percent in June, compared with 2.7 percent in the euro area.

Boosting Forecasts

Foreign-exchange strategists are raising their estimates for the franc more than any other currency, boosting their forecasts for the currency against the dollar by 9.1 percent since April, according to data compiled by Bloomberg.

The median of 38 fourth-quarter estimates is for the franc to end the year at 1.26 francs per euro, from a prediction of 1.34 at the end of April, a separate survey shows.

Geoff Kendrick, head of European currency strategy at Nomura International Plc in London, raised his forecasts for the franc this month, partly because Swiss banks are increasing their assets denominated in the local currency. Nomura predicts the euro will buy 1.2 francs by year-end, from a prior estimate of 1.4 francs. An appreciation to 1.10 over the next three months “sounds reasonable and likely,” Kendrick said.

“It’s definitely possible that we could see parity reached this year if the euro crisis continues,” he said.

Purchasing Power Parity

Gains have left the franc 38 percent too strong against the euro, based on an index developed by the Organization for Economic Cooperation and Development in Paris that uses relative costs of goods and services. It’s also the most overvalued currency against the dollar, at 46 percent.

“The franc is generally underweight in our portfolios because of its overvaluation,” said Thanos Papasavvas, head of currency management at Investec Asset Management Ltd. in London, which oversees about $95 billion. “The valuation of the Swiss franc does not match economic fundamentals.”

The currency may face resistance from the SNB after Vice President Thomas Jordan said on July 13 in Zurich that policy makers are “monitoring the euro-franc exchange rate very closely” and would have “the possibility to act” if there was a threat of deflation, or a general decline in consumer prices.

While the SNB intervened in foreign-exchange markets in the 15 months through mid-June 2010, the franc continued to appreciate.

Company Pain

Zurich-based ABB, the world’s largest maker of power- transmission gear, said in an e-mailed statement on July 8 that the strong franc is causing a “headache.” Basel-based Lonza Group AG, the biggest maker of drug ingredients, said on June 30 it expects a “negative currency effect” of about 60 million to 70 million Swiss francs ($87 million).

The threat of central-bank intervention may not be enough to deter buyers, said Roberto Mialich, a senior currency strategist at UniCredit SpA in Milan.

“There’s broad-based demand for the Swiss franc that’s unlikely to diminish unless risk aversion significantly eases,” said Mialich, who expects the franc to end the year at 82 centimes per dollar.

Italian 10-year bond yields reached 6.02 percent on July 12, with Spanish yields climbing to 6.31 percent the same day, amid concern the debt crisis was spreading to Italy, whose economy is almost three times the gross domestic product of Ireland, Greece and Portugal combined. Mario Draghi, scheduled to replace ECB President Jean-Claude Trichet on Nov. 1, said July 13 that the crisis had entered a “new phase.”

More Franc Strength

The premium for one-month options to sell the euro against the franc, versus those allowing for purchases, surged today to the most since January 2009. The risk reversal rate increased to a 2.73 percentage-point premium for euro puts, up from 1.65 at the beginning of July. A put option grants the right, but not the obligation, to sell a currency.

While currency options suggest franc gains may be stretched, “our platform that measures investor spot positions in the currency suggests that franc strength could continue,” said Caio Natividade, the London-based head of foreign-exchange derivative strategy for Deutsche Bank AG, the world’s largest currency trader, according to Euromoney Institutional Investor Plc. “Investors’ aversion to risk is rising given the euro-zone peripheral-debt concerns, and that will enable the currency to keep appreciating.”

To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net; Liz Capo McCormick in New York at Emccormick7@bloomberg.net

To contact the editors responsible for this story: Daniel Tilles at dtilles@bloomberg.net; Dave Liedtka at dliedtka@bloomberg.net