Unwinding of Swiss franc carry trades fuels safe-haven rally; potential short squeeze could reinforce the move.

A popular bet built around the Swiss franc is unwinding, adding fuel to the currencys rally and raising questions over how far the Swiss National Bank will tolerate appreciation. The franc, a haven when investors are uneasy about Europe, strengthened in October as France was hit by violent protests and political turmoil. The rise has eroded returns from the so-called carry trade, in which investors take advantage of Switzerlands low borrowing costs to put money into higher-yielding currencies. The year-to-date return from selling the franc and buying the euro narrowed to 0.1 per cent last week, down from 3.4 per cent at the end of September. As the trade has become less attractive, asset managers have cut short positions in the franc, according to data from the Commodity Futures Trading Commission; but leveraged funds still hold large net shorts that could drive further gains if positions reverse. If risk-off persists, this residual positioning is a potential source of additional demand for the franc, said Gregor Hirt, global chief investment officer for multi-asset at Allianz Global Investors. The franc strengthened to SFr0.91376 per euro at the end of last week, the strongest level since May, before weakening slightly. Shaun Osborne, chief FX strategist at Scotiabank, said any move below SFr0.90 would make policymakers uncomfortable, especially if the pace of appreciation is rapid. He forecasts a return to SFr0.93 by year-end. SNB officials told the government at a meeting on Wednesday that the central bank was prepared to intervene in the foreign exchange market if necessary. JPMorgan strategists expect the SNB to smooth sharp moves rather than fully stop or reverse franc appreciation. Beyond speculative demand, Florian Ielpo, head of macro at Lombard Odier Investment Managers, argued that Switzerlands strong economy and low government debt meant there was structural demand for the franc, particularly when European politics are tricky. Osborne also noted the SNB might be more tolerant of a stronger franc after Swiss inflation accelerated to 1.5 per cent in October, from 1 per cent a month earlier. Van Luu, head of currency and fixed income strategy at Russell Investments, said he preferred to short the franc against the yen rather than the euro. The risk of currency moves triggered by political turmoil was lower because the yen was also considered a haven currency. The yen was about 50 per cent cheaper against the dollar than it should be, he added, while the franc looked about 20 per cent overvalued against the dollar. Hirt said it was hard for real money investors to materially return to bearish franc bets while European political risk lingered and French budget discussions continued. In particular for European target assets, funding in Swiss franc today means taking European risk by shorting the regional safe haven, he said. We would be cautious there while French spreads are elevated.