FX Focus - AUDCHF: The Tortoise in "The Tortoise and The Hare"

Following  on from last week’s theme of CHF as a funding currency, this week’s focus turns to AUD vs CHF. A quick reminder first of CHF’s funding credentials - the Swiss National Bank (SNB) uses interest rates and FX in equal manner to manage inflation risks and during periods of high inflation, SNB typically raises rates and buys CHF to strengthen the currency to dampen imported inflation risks. But in recent months, Swiss inflation has fallen sharply, averaging just 1.6% in Q4’2023 and well below SNB’s 2% longer term target. Falling inflation in the euro zone and Switzerland alongside downward revisions to SNB’s Swiss inflation forecasts has seen a shift in SNB’s language, de-emphasizing FX intervention at their December meeting, leaving it with little or no incentive to strengthen CHF to contain inflation risks (or to raise rates further).
 

Australia’s Q4 CPI turned up lower than expected. This rests the case for another 25bp hike from the Reserve Bank of Australia (RBA). The CPI result demonstrates Australia’s longer term inflation outlook may have peaked which means RBA rates have also likely peaked. But the RBA is still expected to be the last of the major central banks to cut rates given the stickiness of services inflation, housing, and upcoming tax cuts. Markets are pricing 70bp of rate cuts from the RBA this year, all expected to take place later in Q3 and Q4’2024 compared to 75bp of cuts from the SNB commencing mid-year. With both central banks expected to cut rates by a similar amount (70-75bp by year-end) but with AUD’s cash rate much higher at 4.35% vs 1.75% for CHF, this would leave investors with about 260bp of positive carry on a long AUDCHF position even if the spot rate remains unchanged through this year.
 

But if AUD strengthens against CHF (CHF currently trades at its strongest level vs AUD since 2000), this would likely add to the trade’s appeal. Australia currently experiences both domestic and external resilience and a potentially more supportive risk environment later this year should the Federal reserve be able to engineer a softer landing in the US.  China also plays a key role in AUD’s outlook and here, relative stability in CNY (which now seems to be one of the key objectives of Chinese policymakers this year) to support China’s recovery with further monetary expansion and an infrastructure push that supports a stronger commodities outlook would likely provide stronger support for AUD than was the case in 2023. Note that the Citi Commodities Strategy team maintain their  0-3mth forecast for iron ore, Australia’s largest commodity export to China at $150/t and revise up their 0-3mth forecast for copper, another key export to China, to $8,800/t from $8,500/t amid upside risks from China easing and tighter concentrate supply.