CAD/CHF is a “long-growth”, “short-uncertainty” trade. CAD is correlated with the global energy sector, while CHF correlates with political instability.
In a global economic recession, it is not surprising to see CAD falling and CHF strengthening.
However, as CAD/CHF now rests at long-term lows, over the medium to long term, it is not unlikely that the current time will prove to be a turning point.
CHF remains hotly demanded, likely owing mostly to short-EUR/CHF flows. However, as the world begins to rebound, the premium to own Swiss francs is likely to unwind, while the basis for owning Canadian dollars may improve.
CAD/CHF may not be an especially appealing “long” trade at present, but the long-term trajectory from this current juncture is likely to favor upside.
The CAD/CHF currency pair, which expresses the value of the Canadian dollar in terms of the Swiss franc, continues to trade around its long-term lows that date back to January 2015, the month in which the Swiss National Bank famously withdrew its peg on the exchange rate of EUR/CHF. After dropping the peg, CHF strengthened significantly against all major currencies, including the Canadian dollar (or CAD). I view the 0.6895 level (i.e., just below the 0.69 handle) as a significant support level, which is illustrated in the weekly candlestick chart below (see the horizontal black line).
I last covered CAD/CHF in early February, when I was able to correctly predict short-term downside (the pair subsequently dropped from around 0.74 in February to as low as 0.66 in March). The downside risk I saw was based on the emergence of the coronavirus this year, and following weaker oil prices which were only just beginning to pose as a problem to commodity currencies such as CAD.
Unlike Australia and New Zealand (two countries whose currencies are also considered commodity currencies), Canada is a net oil exporter and has therefore been most vulnerable to the negative oil price swings this year. Indeed, Canada’s terms of trade significantly worsened this year, or at least initially (the indexed chart below illustrates this). Yet more recently, as oil prices have stabilized, it appears that Canadian terms of trade have been able to regain much of their lost ground. Terms of trade measure the ratio between a country’s export and import prices.
(Source: Trading Economics)
However, as we can see in the five-year chart above, Canadian terms of trade have been trending downward for a few years now, and a significant resurgence (beyond current levels) is likely to require much higher oil prices. Oil prices have been trending downward too over the years. However, the possibility of oil prices finally rebounding over the long term is now perhaps higher than ever, given the difficulty of this year for the Oil & Gas sector. As the saying goes, “the cure for low prices is low prices”. This year the sector has faced a combination of both excess supply and a massive demand shock. As the world goes back to work (i.e., as demand picks up), and with restructurings in the oil sector reducing long-term supply, we may indeed witness stronger oil prices over the long term.
Regardless, neither oil markets nor the Canadian dollar appears attractive at the moment. We are still in 2020, the same year in which all of this recent chaos began, and the macroeconomic after-effects are still tough to predict. As fiscal interventions are wound back (monetary interventions are more likely to remain for a long time), we should start to see consumer spending and capital investment take over from government spending (to produce GDP). As interest rates are at all-time lows across all major central banks, discount rates are extremely low and therefore it should not take too long for businesses to start investing again; the key is political stability.
Canada is actually relatively politically stable, but its closest North American ally (the United States) is still yet to settle its November U.S. presidential election. The election is scheduled for November 3, but the incumbent (Trump) has recently been found to have contracted COVID-19. This has thrown a spanner in the works; never before in history has a U.S. presidential election been delayed, but perhaps there is a first time for everything. In a world of heightened uncertainty, we now have even more of it. However, should Trump recover and even win the election, I would expect businesses across North America to feel far more confident in investing. A Biden win would likely prolong the current “uncertainty wave”, although a Biden win would not necessarily be bad for business.
Regardless, the U.S. elections will be tense, and social instability is likely to remain fairly elevated (relative to what we have been used to over the past 10 years or so). On the other hand, while these times are less predictable than before, humans do tend to adapt fairly quickly. Even today, few people even think twice about whether to wear a mask when shopping; it is now automatic for many people, and we have only been using masks for a few months. These might be trying times for many, but ultimately, people adapt and the effects of uncertainty have a lesser and lesser effect on the willingness of consumers to spend and businesses to invest. We adapt, and Western, capitalist democracies always seem to bounce back.
Therefore, while CAD is still languishing, it represents a currency of a major Western, capitalist democracy with a significant energy sector (exporting energy products that the world still largely depends on in spite of the many new green initiatives). At these low levels, being short CAD is to be short history in the sense that it would be almost a vote against the world bouncing back. CHF is a safe haven, which has been hotly demanded this year, for fairly straightforward reasons. But as “uncertainty premiums” unwind, and as we bounce back, I believe CAD/CHF could stage a significant comeback.
The rates environment does not present much bias either way though at present. The Bank of Canada’s short-term rate is +0.25%. The Swiss National Bank’s comparable rate is still negative at -0.75%. The spread is therefore clearly in favor of CAD, even if neither of these rates are even 100 basis points wide in absolute terms. On the other hand, Swiss inflation is currently around -0.80% (September 2020) while Canadian inflation is running at closer to zero at +0.10% (August 2020). If we adjust these central bank rates for inflation, the CAD rate is positive by 15 basis points, and the CHF rate is positive by 5 basis points (these are akin to “real yields”).
Since Canadian inflation is likely to rebound quicker than Swiss inflation (unless EUR/CHF strengthens considerably to the benefit of Swiss export competitiveness), it is probable that CAD and CHF rates (adjusted for inflation) are likely to remain about even over the medium term. Meanwhile, Canadian GDP sank by 13% in Q2 2020, while Swiss GDP sank by a lesser 8.3%. Still, by now we could expect these adjustments to have been priced in, and going forward, we might expect a sharper rebound in Canadian GDP versus Swiss GDP, which could support the case of CAD. This is admittedly only one possibility of several, however.
Brexit uncertainty (the deadline for the U.K. to have a formal trade deal with the EU is year-end) is still likely supporting CHF demand over EUR demand. The size of the Swiss economy relative to the euro area means that currency markets will always naturally place upside pressure on the CHF/EUR rate, but perhaps we will see less upside pressure into 2021 as markets may begin to settle in relation to Brexit (the current uncertainty continues to fuel demand for GBP options and hedging instruments).
Based on the OECD’s Purchasing Power Parity model, in 2019, the fair value of CAD/CHF (based on the relative purchasing power of these two currencies) was approximately 0.96. In other words, CHF is fairly excessively overvalued, but this financial tragedy for Switzerland seems fairly pervasive and, as alluded to earlier, is led by short-EUR/CHF demand (CHF is a natural alternative for EUR holders). Swiss interest rates are already the lowest across all G10 nations and have been for many years.
The situation with the Swiss franc may continue, which is certainly likely to restrain any CAD/CHF upside. Confidence is also still low in the energy sector (I even read an article recently discussing an ETF which tracks the S&P 500 excluding energy stocks; the level of despondency is high). Nevertheless, the world will eventually bounce back, and CAD/CHF in some sense represents a “long-growth”, “short-uncertainty” trade. Going “long growth” and “short uncertainty” has not been popular in recent times, but good times last longer than bad ones, and soon we will move from recessionary times to the beginning of a new economic cycle, in which CAD/CHF is likely to reverse.
Further consolidation is likely for CAD/CHF over the medium term, but as we push into 2021, I believe the long-term trajectory is likely to be upward. It would make sense for CHF to strengthen as the world moves into recession, but recessions effectively represent the peaks of economic weakness in each business cycle, and as such this present time could prove to be the start of the turning point in which the premium to own Swiss francs begins to unwind.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Originally published on Seeking Alpha