the Swiss Franc is normally one of the most subdued currencies whose moves are usually dictated by the market’s appetite for the euro and U.S. dollar but when geopolitical tensions are at play it’s a completely different animal. Volatility in the Swiss Franc skyrocketed in recent weeks. Less than 2 months ago, 1 month USD/CHF implied option volatilities were hovering near 5.5% and today they are at 8.2% but the biggest explosion can be seen in EUR/CHF where volatility of the same tenor jumped from 3.5% to 8% over the past 6 weeks. Today’s 1% rally was triggered by escalating tensions between the U.S. and North Korea but rising geopolitical risks is not the only reason why EUR/CHF’s daily range expanded from 30 to 100 pips. The big moves in the Swiss Franc started when the market woke up to the reality that Swiss monetary policy will lag behind the rest of the world and then it continued as the war of words between the U.S. and North Korea escalated. Today, U.S. Defense Secretary Mattis officially put North Korea on notice after President Trump retweeted multiple Fox new reports citing either him or the government sources saying U.S. air force jets take off from Guam for training, ensuring they can fight tonight as the U.S. warns they will respond to North Korean threats with “fire and fury” if they make any further moves. While the actual threat of nuclear war is slim until the war of words makes a positive turn, investors will fear the improbable as too many unlikely events have become reality in the past 12 months. At the same time, the sharp volatility in the Swiss Franc invites SNB activity although we don’t expect them to be seriously worried until EUR/CHF sinks back to 1.11. Swiss Franc volatility will subside eventually but the days of 30-40 pip ranges could be behind us for sometime as EUR/CHF aims for 1.12.
The U.S. dollar has also been negatively affected by how Trump is dealing with North Korea but dovish comments from Federal Reserve Presidents kept the greenback under pressure. Although Chicago Fed President and FOMC voter Charles Evans backs balance sheet unwind in September he said recent inflation weakness raises questions on the outlook, a sentiment that was shared later by Fed President Bullard. This concern is reflected in unit labor costs growth, which slowed to 0.6% in the second quarter, down from 5.4%. Producer prices are scheduled for release tomorrow and they could shape expectations for Friday’s more important report on consumer prices. Having stagnated in June, CPI is expected to tick higher but if stronger wage growth and a lower unemployment rate failed to help the dollar last week, it is hard to imagine that 0.2% CPI growth would be enough. Meanwhile euro and sterling ended the day unchanged against the greenback. No economic reports were released from either country but tomorrow will be a busy day for sterling with UK industrial production and trade balance numbers scheduled for release. Given the uptick in the manufacturing PMI index, stronger numbers are anticipated although any rally for GBP/USD could still be capped at 1.3060.
The big focus tonight is on the Reserve Bank of New Zealand’s monetary policy announcement. We published our outlook yesterday and will reiterate it today. The RBNZ is widely expected to leave interest rates unchanged but the sell-off in the New Zealand dollar over the past few days tells us that investors are positioning for less hawkishness from the central bank. When the RBNZ last met in June, they overlooked the 4% rise in NZD/USD between the last 2 monetary policy meetings and chose to say the “lower currency would help rebalance growth.” They were able to do so because the New Zealand economy actually performed better between May and June. However since then as shown in the following table, there has been significant deterioration in New Zealand’s economy and on top of that NZD/USD rose another 3 cents before peaking in late July. For all of these reasons, we believe that the Reserve Bank will be less optimistic but at the same time worries about a strong currency is assured as we don’t need to reach far for reasons that could disappoint investors who have been selling the New Zealand dollar before the policy announcement. The New Zealand dollar is trading not far from where it was at the last meeting against the U.S. dollar and is actually 3.8% lower against the currency of its most important trading partner, the Australian dollar. This could explain why AUD underperformed NZD today following softer data – consumer confidence in Australia declined this month, home loans grew at about a third of the pace that was expected while inflation in China slowed. The Canadian dollar also lost value but that had more to do with risk aversion as oil prices and Canadian housing starts ticked higher.