The Swiss-euro cross

Any discussion of the EUR’s long-term history has to factor in one non-economic reason for its weakness in 2000-2001: the sale of “legacy” currencies hidden from the various national tax collectors prior to the introduction of cash euros in 2002. This so-called “mattress trade” made the CHF/EUR unnaturally strong during those years.

The difference in two countries’ FRRs can be used to compare their monetary policies. A country whose FRR is greater than another’s has a looser monetary policy and, all else held equal, its currency should weaken.

All else seldom is held equal, however. The Swiss FRR has exceeded its Eurozone counterpart since late 2001, but it did not break its trend support (dashed line) until the March 2003 Swiss rate cut. The CHF/EUR then collapsed under the weight of looser Swiss monetary policy, and that weakness persisted through late 2006 even though the Swiss FRR is flattening relative to the Eurozone FRR. It will take a renewed tightening of Swiss monetary policy to change this.

Will this happen anytime soon? The message from the cross-rate options market is, “No.” The cost of buying options on the CHF has declined steadily for EUR holders since the 2003 rate cut — which implies EUR holders who have borrowed the CHF and swapped it into EUR have no fear the CHF will strengthen anytime soon. Of course, these same CHF borrowers are increasing the risk of the underinsured event — a sudden rise in the CHF — by creating a path of greatest anxiety in that direction.