The Zhitong Finance App learned that as investors use the Swiss franc as an alternative to yen for arbitrage transactions, there is still a risk that the Swiss franc will rapidly appreciate again.

The Swiss franc has long been used by arbitrage traders as a financing currency. In so-called arbitrage trading, traders borrow a currency with a low interest rate and exchange it for another currency to buy an asset with a higher yield.

As the yen depreciated, the Swiss franc became even more attractive. In August, the yen rose sharply due to weak US economic data and the Bank of Japan's unexpected interest rate hike. As a result, yen arbitrage trading collapsed, causing turmoil in the global market.

Swiss franc's new favorite for arbitrage trading

The SNB was the first major central bank to launch an easing cycle earlier this year. Its key interest rate remained at 1.25%, allowing investors to borrow Swiss francs to invest elsewhere at a low cost.

In contrast, interest rates in the US range from 5.25% to 5.50%, the UK 5%, and the Eurozone 3.75%.

“The Swiss franc has once again become a financing currency,” said Benjamin Dubois, global head of asset management at Edmond de Rothschild Asset Management Suisse.

The Swiss franc is close to eight-month and nine-year highs against the US dollar and the euro, respectively, reflecting the Swiss franc's status as a safe-haven currency and the market's expectations for interest rate cuts in Europe and the US.

Investors, however, want the Swiss franc to gradually depreciate, thereby increasing the return on arbitrage transactions.

According to data from the US Commodity Futures Trading Commission (CFTC), speculators suddenly switched to long positions worth 2 billion US dollars in yen while still holding short positions worth 3.8 billion US dollars in Swiss franc.

Analysts often see large short positions as a sign that a currency is being used to fund arbitrage transactions.

Traders drastically cut their bets on shorting yen in early August

Kamal Sharma, senior foreign exchange strategist at Bank of America G10, said, “The yen is currently facing greater two-way risk than it has been for quite some time. The Swiss franc seems to be the more reasonable financing option.”

Bank of America advises investors to buy GBP/CHF, saying that due to the huge spread between Switzerland and the UK, the pound may rise, and Goldman Sachs shares the same view.

As inflation falls, it looks like the SNB will cut interest rates further in the coming months. This will reduce the Swiss franc's borrowing costs and may put pressure on the Swiss franc, thereby reducing repayment costs for those who have already borrowed in the Swiss franc.

SNB officials also seem unwilling to see the Swiss franc strengthen further, in part because it will cause pain for exporters. Bank of America and Goldman Sachs believe that the Swiss central bank took action in August to devalue the Swiss franc.

Michael Cahill, Goldman Sachs G10 foreign exchange strategist, said, “The Swiss central bank may prevent the appreciation of the local currency through necessary intervention or interest rate cuts.”

Risks still exist

Due to the Swiss franc's long-standing safe-haven reputation, investors tend to buy the currency in large quantities when they are nervous.

Cahill said the Swiss franc is best used as a financing currency when investors are optimistic.

The rapid appreciation of the currency financed by arbitrage trading may wipe out earnings and cause investors to quickly close their positions, as shown by the trend in yen. A fall in volatile or high-yielding currencies can have the same effect.

When the media asked about the impact of arbitrage trading on the Swiss franc, both the SNB and the Swiss Financial Market Supervisory Authority declined to comment.

As the stock market fell sharply in early August, the Swiss franc rose 3.5% in two trading days. As it turns out, the Swiss franc is very sensitive to the US economy against the US dollar. Weak US economic data often causes US Treasury yields to fall, while the Swiss franc usually rises sharply against the US dollar.

The volatility of the USD/CHF exchange rate has risen sharply

Michael Puempel, a foreign exchange strategist at Deutsche Bank, said, “Any arbitrage trade is inherently risky, especially for traders who use safe-haven currencies to finance.”

Puempel added: “The main risk is that when the yield falls in a safe-haven environment, the yield difference will be compressed and the Swiss franc may rise.”

An indicator that measures investors' expectations of the Swiss franc's trend is currently at its highest level since March 2023.

Nathan Vurgest, head of the trading department at Record Currency Management, said: “Considering the policies of major central banks, you can see that some arbitrage participants may prefer the Swiss franc over the yen.”

Vurgest said, “The ultimate success of this kind of arbitrage transaction may still depend on how quickly the position can be closed in a safe-haven situation.”