WE ARE on a bumpy road with a very few spare tires,” said Pimco chief executive Mohamed El-Erian, just before US equity markets opened for trade yesterday morning. I couldn’t agree more. Capital markets are in turmoil and the primary reason for the meltdown is the absolute lack of confidence in American and European leadership. The aftermath of the downgrade of US debt to AA+ along with the continuous rise in Spanish and Italian bond yields are clear signs that markets have lost faith in governments on both sides of the Atlantic and are now frantically fleeing into the safety of the Swiss franc.
Last week, I half jokingly noted that euro-Swiss franc at parity was possible by the end of this year. With the pair having come within a few pips of the SFr1.0500 level yesterday, parity is no longer a laughing matter. Meanwhile, dollar-Swissie has broken the key psychological level of SFr0.7500, reaching a new record low of SFr0.7360. The pair is grossly oversold and has essentially been a one-way trade for nearly a month, but there is little on the horizon to suggest that it can stage a counter-trend rally.
With President Obama rendered ineffective by Congress and European leaders unwilling to accept the reality that in order to maintain a single currency they need a common Eurobond, the only source of leadership left is the US Federal Reserve. Although the impact of its various quantitative easing (QE) programmes has been limited at best, Fed authorities may have no other choice but to act once again as the buyer of last resort. Generally, QE would be viewed as dilutive and therefore negative for the dollar. However, QE’s positive impact on risk assets will likely outweigh any concerns over further expansion of the US monetary base, and dollar-Swissie could finally rebound on a relief rally in risk.