Traders Burned on Swiss Franc Carry Shun Free Money: Currencies

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(Bloomberg) — When it comes to Swiss-franc carry trades, it’s a case of once bitten, twice shy.

Switzerland’s negative interest rates mean investors are effectively being paid to borrow francs, which they could then use to purchase higher-yielding assets denominated in other currencies. Carry trades funded in the Swiss franc would have made more this month than deals using either euros or yen, data compiled by Bloomberg show.

Yet the specter of Jan. 15 — when the Swiss National Bank ditched its exchange-rate cap, sending the franc soaring and wiping out returns — looms large. Investors from Amundi to UBS Wealth Management AG say they’re reluctant to re-enter the trade, a blow to SNB President Thomas Jordan, who said Tuesday in Brussels that the franc remains overvalued.

“To be a good funding currency, it needs to be more stable,” James Kwok, the London-based head of currency management at Amundi, which oversees about $1 trillion, said Tuesday by phone. Still, if volatility abates, “it will be one of the good candidates,” he said.

Investors in carry trades borrow cheaply in one currency to invest in another where interest rates are higher. They profit both from the rate differential and any appreciation in the purchased asset.

Price Swings

Two things hurt returns: an appreciating funding currency and higher volatility, because adverse price moves can wipe out the benefit from the pick-up in rates.

The SNB caused both when it removed the franc’s 1.20-per- euro cap, sending the currency through parity with its 19-nation peer for the first time. A Credit Suisse Group AG index of carry-trade returns plunged 13 percent Jan. 15-16, the most ever.

While the franc has since pared its gains, and price swings have become less pronounced, the events of last month make franc-funded deals still too risky for many.

“For the time being, we’re cautious,” Thomas Flury, the head of foreign-exchange research at UBS Wealth Management, the investment arm of Switzerland’s biggest bank, said by phone from Zurich on Tuesday. “There’s this one-sided risk that the Swiss franc will appreciate again. Volatility is still very high.”

If he does franc-funded trades in the future, Flury said he’d use the Swiss currency to buy dollars or British pounds to benefit from a pick-up in interest rates. The SNB lowered its deposit rate to minus 0.75 percent the same day it scrapped its currency ceiling.

Popular Trade

The franc has long been used for funding carry trades because its near-zero borrowing costs pre-date those of many other economies, which only cut rates in response to the 2008 financial crisis. The carry trade is the most popular strategy in the $5.3 trillion-a-day foreign-exchange market, according to the Bank for International Settlements in Basel, Switzerland.

Because the deals tend to debase the funding currency, investors’ reluctance to use the franc is making it harder for the SNB’s Jordan to keep his nation’s exchange rate in check. In a speech in Brussels on Tuesday, the central-bank chief said he’s prepared to intervene in currency markets to weaken the franc because its strength creates “headwinds” by making the economy less competitive.

Investors shunning franc carry trades may be passing up significant profits. Selling the Swiss currency and using the proceeds to buy 22 of 23 major emerging-market peers is making money this month, with returns ranging from 1.2 percent on South Korea’s won to 14 percent on the Russian ruble, data compiled by Bloomberg show.

Yen Returns

Potential franc returns are slightly more than those on yen-funded trades, which have made from 0.8 percent to 13.5 percent this month, while only six euro deals would have made money, data compiled by Bloomberg show.

The improvement in franc-funded carry returns is underpinned by the currency’s losses this month. The franc has weakened 2.8 percent versus the euro in February, headed for its biggest monthly decline since its cap was introduced in September 2011. It traded at 1.0694 francs per euro on Tuesday in New York, weakening from a record 85.17 centimes the day of the SNB’s announcement.

Implied three-month volatility on the euro-franc rate, a measure of anticipated price swings in the next three months, jumped to a record close of 24.88 percent on Jan. 16, before falling back to 11.02 percent on Tuesday.

That volatility means the SNB’s Jordan is unlikely to get much of a helping hand.

“High volatility is the death of a carry trade,” Simon Derrick, the chief markets strategist at Bank of New York Mellon Corp. in London, said by phone on Monday. “To all intents and purposes, you have the SNB paying you to use their currency as a funding currency. But you need people to feel comfortable enough with the risk-reward.”

To contact the reporter on this story: Lucy Meakin in London at [e-mail] To contact the editors responsible for this story: Paul Dobson at [e-mail] Paul Armstrong, Caroline Salas Gage