Carry traders pivot to Swiss franc as yen volatility spikes

The Swiss franc is again a haven against volatility Keystone / Gaetan Bally

Carry traders are increasingly turning to the Swiss franc in the near term for their source of funding as the threat of intervention and higher interest rates saps the appeal of borrowing in the yen.

Hedge funds boosted their net short position in the franc to near a two-month high in the week through August 11, according to the latest data from the Commodity Futures Trading Commission. At the same time, they reduced their yen shorts for a second week.

“The market has recently added short Swiss franc exposure to fund foreign-exchange carry trades,” said Tobias Jungmann, head of Americas foreign-exchange options at Bank of America in New York. The ratio of volatility versus carry for franc-funded emerging-market trades also make options an attractive way to gain exposure while limiting risk, he said.

The appeal of borrowing in the franc is underpinned by Swiss interest rates that are near zero and also by the central bank’s readiness to limit any currency appreciation. By contrast, investors are growing wary of yen-funded trades after Japanese and US intervention to strengthen the currency in late July pushed up its volatility.

Japan’s government is supportive of a near-term rate hike by the central bank, people familiar with the matter said last week.

Interest rate strategy

The franc’s attraction as a funding source is building as it lays the foundation for higher carry returns. A strategy of borrowing in the Swiss currency and investing in the higher-yielding Mexican peso has gained almost 4% over the past month, while a similar trade using yen funding returned just 1.3%, data compiled by Bloomberg show.

A carry trade is an investment strategy where an investor borrows in a currency with a relatively low interest rate and invests the proceeds in another with a higher interest rate, profiting from the interest rate differential or ‘carry’.

“There may be some yen carry trades, but these days, after 2024, when large intervention hurt the carry trade, people are more cautious,” said Stephen Jefferies, head of currencies and emerging markets at JPMorgan Chase in London. There has recently been some demand for alternative funding currencies such as the franc and euro, and even the Taiwan dollar, he said.

The yen’s long history as a funding source for carry trades means it still has adherents.

The Bank of Japan’s benchmark policy rate of 1% is lower than that of most of its developed-market peers, while concern over Japan’s long-term fiscal outlook is also weighing on the currency. The yen has already erased more than half of the gains it made following the intervention.

“The yen remains the world’s dominant funding currency, and the recent intervention has done little to change that underlying reality,” said Markus Schmidt, head of linear FX and local-market rates trading in Europe at Credit Agricole CIB in London.

As long as Japan’s rate differential with other economies remains wide, carry traders will keep returning to yen shorts, he said.

‘Reverse knock-out’

Nomura Singapore has recently “seen some tentative interest return to long yen crosses — euro-yen, Aussie-yen and kiwi dollar-yen — on the dip,” said Graham Smallshaw, a senior foreign-exchange spot trader at the company.

These are done predominantly through option contracts known as ERKOs, he said, referring to European reverse knock-outs, which include a barrier that cancels the trade if the currency pair breaches a specified threshold.

Others say the franc is still preferred over the yen, at least for now.

“The Swiss franc carry trade is more popular,” said Steve Brice, global chief investment officer for group wealth management at Standard Chartered in Singapore. “That’s where we see more of the carry trade coming from.”

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