The Swiss franc temporarily steals the limelight from the yen, becoming the "new favorite" for arbitrage traders' financing.

Due to the threats of intervention and higher interest rates weakening the appeal of the yen as a funding currency, arbitrage traders are turning their attention to the Swiss franc. Data from the Commodity Futures Trading Commission (CFTC) shows that as of the week ending August 11, hedge funds have pushed net short positions in the Swiss franc to a nearly two-month high. Meanwhile, they have reduced their short positions in the yen for the second consecutive week. Hedge funds are shorting the Swiss franc. The cost of financing and currency intervention are key considerations. Tobias Ronnman, head of Americas FX options at Bank of America in New York, stated, "The market has recently added short positions in the Swiss franc as a way to finance forex arbitrage trades." He also noted that the volatility of emerging market trades funded by the Swiss franc relative to arbitrage returns makes options an effective means to gain exposure while limiting risk. The financing attractiveness of the Swiss franc stems from Switzerland's near-zero interest rate level and the Swiss National Bank's willingness to prevent significant appreciation of the franc. In contrast, at the end of July, Japanese and U.S. authorities raised the yen's exchange rate, leading to a spike in yen volatility and prompting investors to be wary of yen financing trades. Last week, informed sources revealed that the Japanese government supports the central bank's interest rate hikes in the near future. Higher interest rate differentials are enhancing the attractiveness of the Swiss franc as a funding currency. Data shows that over the past month, strategies borrowing Swiss francs to invest in high-yield currencies like the Mexican peso have yielded nearly 4% in total returns; in comparison, similar strategies financed with yen only achieved a return of 1.3%. Simply put, arbitrage trading refers to investors borrowing low-interest currencies and reallocating them to high-interest currencies to earn interest differentials. Stephen Jeffries, head of FX and emerging markets at JPMorgan in London, expressed, "The large-scale intervention actions in 2024 severely impacted yen carry trades, and participants in the market are still wary of this." He also pointed out that there has been a recent uptick in demand for alternative funding currencies such as the Swiss franc, euro, and even the New Taiwan dollar. However, the yen has long been the preferred funding currency for arbitrage trading and is still favored by some industry insiders. The Bank of Japan's policy rate of 1% is lower than that of most developed market countries, and concerns about Japan's long-term fiscal situation also put pressure on the yen. The yen's exchange rate has now retraced more than half of its gains after the intervention. "Yen remains a major global funding currency, and recent interventions have not changed this fundamental reality," stated Marcus Schmidt, head of European linear foreign exchange and local market rates trading at Crdit Agricole. As long as the interest rate gap between Japan and other economies remains, arbitrage traders will continue to short the yen. Graham Smallshaw, a senior spot FX trader at Nomura Singapore, noted that as the yen's exchange rate has recently retraced, the company has observed increased market interest in going long on yen cross pairs (such as euro/yen, aussie/yen, and kiwi/yen). These trades are mainly executed through European-style reverse knock-out options (ERKO). Some market participants believe that at least at this stage, the Swiss franc remains the more favored financing choice. Steve Brice, global chief investment officer at Standard Chartered Bank in Singapore, candidly stated, "Swiss franc arbitrage trades are more popular. We've seen more arbitrage trades funded from the Swiss franc."