What the Swiss Can Really Do About the Franc

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The Swiss franc is sliding on worries it will be pegged to the euro. But it's not clear a peg is really feasible.

The way the Swiss franc has been falling, you would think those crazy Swiss have really been misbehaving - but that's only true if you count tough talk. In an attempt to stem the franc's rise, a Swiss National Bank official last week said a peg to the euro could not be ruled out. The Swiss are to announce their plans for the franc tomorrow, and everyone has been bailing on what had been the top performing currency all year.

But could the Swiss really pull it off? Not likely, says Lena Komilev, global head of G10 currency strategy at Brown Brothers Harriman.

"A euro peg is not the easiest step to consider for Switzerland, either politically or legally. Staying out of the euro zone has been Switzerland’s democratic choice," she wrote in a note to clients. "Domestic voters may well feel that measures to support corporate profitability and export diversification via a much laxer fiscal policy would be a better way to spend public funds rather than to turn the SNB into a bad bank and a shadow bailout vehicle for the Euro zone periphery via a peg with the euro."

The strong franc has been a millstone for Swiss businesses, and many business leaders are cheering on the Swiss National Bank's actions. But until now, its attempts to intervene in the Swiss franc's rise have been unsuccessful - and expensive. Analysts like Paresh Upadhyaya, head of G10 FX strategy for the Americas at Bank of America Merrill Lynch, are skeptical that they can come up with a plan that isn't prohibitively expensive or unworkable.

"The backdrop for this to be successful is missing, I think," he told me. "The reason behind the huge appreciation of the Swiss franc is that it is viewed as the number one anti-peripheral currency." And that isn't just appealing to short-term investors. Upadhyaya says that since the sovereign debt crisis erupted, about 25% of Greek savings have moved into foreign banks, either outside the country or in foreign banks' Greek offices. That's an enormous reservoir of demand for a small country's currency.

"As long as the market concerns on the peripheral debt remain," along with the prospect of ultra-low U.S. interest rates for a long period, "it's very difficult to see how Switzerland can buck this trend," Upadhyaya told me. "The early reports indicate that there is broad based political support for the Swiss National Bank to use whatever resources they have to intervene to weaken the franc, but the proof is in the pudding.

How can you trade the prospect of a peg? Upadhyaya recommends standing pat, given the uncertainty about the plan, unless you are already short euro-Swiss above 1.20. But, he says, "I certainly wouldn't recommend buying euro-Swiss."

Stay tuned for Wednesday's news.

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