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U.S Dollar Strength: Temporary, or a long-term trend?

The Dollar Index (DXY) has been positive going into 2021, returning just under 2% year to date. Goldman Sachs. With Goldman Sachs and other large institutions touting their bearish views due to Joe Biden’s stimulus, low-interest rates and an appetite for Gold, the recent strength in the dollar has tested their analysis.

DXY has returned just over 2% since the start of 2021.

However, with Morgan Stanley abandoning their calls for a weaker greenback, with Matthew Hornbach stating that “It’s no longer attractive to be positioned for a weaker dollar from here given the uncertainties around the fiscal policy outlook, the monetary policy outlook, and the growth and inflation outlook,” are we seeing a turn in consensus?

Quicker return to normal providing tailwinds for the U.S Dollar

Analysts are looking at the pace of vaccinations in the United States and worldwide, with predictions being made that a return to normal may be sooner than we think, especially when financial markets and economic policy are concerned. Federal Reserve minutes suggest that a possibility of talks regarding the normalization of monetary policy can start as early as June.

Millions still remain unemployed due to the Coronavirus

A quicker and more robust recovery may mean Republicans may have a leg to stand regarding a lower stimulus figure. Later this week ahead, we will see the non-farm payroll numbers for January. A higher-than-expected figure may suggest that the American recovery is faster than expected, and a lower stimulus figure from the 1.9 Trillion headline figure suggests. Lower than expected stimulus should put less downwards pressure on the supply side of the U.S Dollar.

Swiss Franc may be the Most Vulnerable

USD/CHF draws similarities to the DXY

With both the U.S Dollar and the Swiss Franc being relative currency safe havens, relative strength in one will bode strong movements in the other. The U.S Dollar has appreciated over 2% year to date, with Morgan Stanley analysts suggesting to short the Swiss Franc against the Canadian dollar while waiting on signs to turn bullish on the U.S dollar.

USD/CHF approaching 0.89, a strong resistance level

The USD/CHF is down around 10% since the peak of the Coronavirus in mid-March, as further dollar weakness continues to increase the value of the safe haven, the Swiss Franc.

This recent strength in the Swiss Franc has broken a strong range the USD/CHF has been trading in for the past couple of years, between 0.95 and 1.05. It has ranged between these points after the Swiss National Bank decided to stop pegging the Swiss Franc against the Euro unexpectedly in 2015. We saw the pair break a strong support level around 0.934, a 78.6% Fib retracement level.

USD/CHF over 6 years

Why are we seeing the Swiss Franc get stronger?

Historically post peg, the pair has been trading in relative parity to each other, highlighting the battle between the demand for the world's reserve currency alongside the demand for a safe haven such as the Swiss Franc. However, U.S. dollar weakness has strengthened many currencies opposite to it, including the Swiss Franc.

A couple of months ago, the Swiss National Bank intervened in the currency market to cap the Swiss Franc's appreciation, with Credit Suisse estimated that the Swiss National Bank had sold over $98 Billion in Swiss Franc's in the first half of this year alone. The Swiss National Bank believes that the Franc's appreciation would be detrimental to the economic recovery in Switzerland. The SNB's balance sheet is around $1 Trillion, with their foreign reserves at an all-time high. For reference, Switzerland's economic output is about 700 Billion.

Dollar weakness is the key to the strength of the Swiss Franc, and that dollar weakness is coming from the global economic recovery from the Coronavirus. If the vaccine rollout successful in the U.K. and then across the world, dollar weakness will continue to push the Swiss Franc stronger and further away from parity.USD/CHF approaching 0.89, a healthy resistance level

Swiss Franc - Heading below 0.92 against the USD?

We saw a retest of the 0.92 mark in early September when the Swiss Franc against the U.S. Dollar rallied as investors embraced the currency's safe-haven status. Will we see a further strengthening of the Swiss Franc?

USD/CHF over 10 years with a strong support/resistance area at 0.92

Where did the Swiss Franc get its "Safe Haven" reputation?

In 2011, the Swiss National Bank pegged the Swiss Franc at 1.20 against the Euro as investors and traders holding the Euro flocked to the Swiss Franc. The shift in sentiment was due to the European Debt Crisis, where major countries in the European Union, such as Greece, Spain, Portugal, and Ireland, could not pay/refinance their government debt. To control the appreciation from investors and traders flocking to the Swiss Franc due to the Swiss Government's stability, they pegged the Swiss Franc to the Euro. An appreciation in the Swiss Franc made their exports more expensive.

However, the SNB unexpectedly removed the peg in 2015, causing the Swiss Franc to rally against the Euro and the Dollar.  Since then, the SNB has been trying to control its currency appreciation via negative interest rates and quantitative easing.

Swiss Franc draws away from U.S. dollar volatility

As we head into a volatile period, investors and traders may want to look at safe havens to preserve capital alongside potential moves to the upside. The Swiss Franc has seen this pressure as a safe haven from traders recently, as it retested that 0.92 mark. In a period where exports are critical to a better recovery from the Coronavirus, an appreciation of a currency would not be wanted. That's why the SNB has spent around $98 Billion USD to try and control the appreciation. However, the Swiss Franc has still appreciated around 5.7% year to date.

However, that key point above, where exports from Switzerland get more expensive, is the exact reason why traders and investors are betting on appreciation – it puts less attention on Switzerland as it is less of a threat to the United States. For example, President Donald Trump has targeted China and the European Union due to them lowering interest rates, weakening their currency, and boosting their exports. The initial peg in 2011-2015 and the appreciation from 2015 when the peg was disabled saw Switzerland be put on the U.S. Treasury's watchlist as a currency manipulator. However, an appreciation of the Swiss Franc against the U.S. dollar may alleviate the supposed threat against the United States' exports. As Peter Kinsella, Global head of foreign exchange strategy at Union Bancaire Privee, "The U.S. administration possibly has bigger fish to fry."