Swiss Franc to Parity with the Euro? What are the Odds?

While there has been some talk of a Swiss sovereign wealth fund, it might raise more problems than it solves. Companies facing an adverse currency shock typically have two strategies. The first is boosting productivity which helps blunt the loss of competitiveness induced by the over-valued currency. The second is to increase foreign direct investment to diversify operations away from strong currency area.

The Swiss franc's function as a safe haven has been put on steroids by the global debt crisis in general and the European debt crisis in particular. There is speculation that over time it is likely to move to parity with the euro. Indicative pricing in the options market can shed some light on the issue.

Using current spot and implied volatility, we estimate that the odds that the euro falls to CHF1.0 before the end of the year is about 14%. The odds of such an event over the next 12 months is almost 35%.

While not the odds-on favorite, it seems sufficiently high that it cannot be simply ignored.

For equity investors, the news is not good. The appreciation of the Swiss franc against the euro is one of the reasons why the Swiss Market Index (SMI) has generally underperformed. Year-to-date the SMI is off 7.3%, while the Dow Jones Stoxx 600 is off a little less than 3% and the DAX is up 4.4%.

The SMI is inversely correlated with the Swiss franc's strength against the euro. On a 60-day percent change basis, the inverse correlation is near -0.5. Only five times over that period the inverse correlation has been -0.6 or beyond.

Switzerland, like the US, is in the middle of earnings seasons. On Thursday several key companies report--including Roche, Actelion and ABB. Some companies do report their earnings in US dollars, but this offers little comfort.

It is difficult for companies to cope with the competitive implications of the persistent strength of the Swiss franc. By the OECD calculations, the Swiss franc is the most over-valued currency in its universe near 45% over -valued against the dollar and 37.5% over-valued against the euro. The more simple Big Mac calculations, put the over-valuation against the US dollar at almost 115% and 63% over-valued against the euro.
Swiss Franc to Parity with the Euro? What are the Odds? Swiss Franc to Parity with the Euro?  What are the Odds? Reviewed by Marc Chandler on July 20, 2011 Rating: 5
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