Euro, dollar could rally further vs Swiss franc

NEW YORK Fri Aug 12, 2011 5:16pm EDT

A picture illustration shows a U.S. dollar bank note and a one Euro coin, taken in Warsaw January 26, 2011. REUTERS/Kacper Pempel

A picture illustration shows a U.S. dollar bank note and a one Euro coin, taken in Warsaw January 26, 2011.

Credit: Reuters/Kacper Pempel

NEW YORK (Reuters) - The euro and dollar looked to extend gains against the Swiss franc in the upcoming week as investors remained cautious about potential Swiss National Bank action to slow the pace of the franc's rise.

Both the euro and dollar have racked up gains of roughly seven percent the last two sessions. On Thursday, the SNB said it could peg the franc against the euro, propelling both currencies to their best one-day gains ever.

The approval by the Italian cabinet of the country's austerity plan did contribute to bids in the euro as well late in the session. The single currency rose as much as 2 percent on the day versus the Swiss franc.

The yen, meanwhile, hovered in a tight range near a record high versus the dollar on Friday, as markets remained alert for possible Japanese intervention to halt its rally.

The Japanese currency is expected to remain wedged in tight ranges next week, with investors unwilling to test Japan's resolve to keep the yen lower.

Investors though remained transfixed on price action in the Swiss franc crosses given the size of the moves.

Pablo Frei, portfolio manager and senior market analyst, at Quaesta Capital in Zurich, Switzerland said investors have become a little more cautious about driving the Swiss franc higher given the SNB's recent statements.

Quaesta Capital is a currency fund of funds with assets under management of about $3.5 billion.

"They're asking themselves whether the franc is trading at a level that would still make sense for investors to buy."

Overall, Frei said news from either the United States or Europe could drive the foreign exchange market next week, adding that currency managers tracked by Quaesta have remained generally risk-averse with short positions on the euro and Australian dollar and longs on the yen.

"Investors are hoping things will improve in both the U.S. and Europe so they don't have to think about the Swiss franc anymore," Frei said.

OVERVALUATION IN SWISS FRANC

In late afternoon trading, the euro rose 2.0 percent to 1.10780 francs, rebounding from a record low of 1.0075 set on trading platform EBS on Tuesday. Despite the latest move, the euro was still down 11.3 percent this year and about 2.6 percent lower this month.

The Swiss franc has become the most overvalued currency, even more expensive than the Brazilian real, according to Goldman Sachs estimates. At one stage this week, the franc was overvalued by as much as 71 percent.

Implied volatility on euro/Swiss franc, a gauge of the market's expectations of future movements, slipped on Friday in choppy trading as the pair swung from negative to positive territory. One-month euro/franc implied vols closed at 22.65 percent from 22.25 percent on Thursday. These levels though were below the record of 32 percent hit on Tuesday.

DOUBTS ABOUT THE FX PEG

As the market digested the possibility of a currency peg in the Swiss franc, most market participants have expressed doubts about its viability.

A peg -- essentially placing a ceiling on the franc -- could open the SNB to unlimited selling in the Swiss currency and reserve accumulation and analysts considered the move unlikely for now. Traders have cited speculation that the euro/Swiss peg could be fixed at 1.15 francs.

"If the SNB commits to a peg, whether at current levels or higher, their intervention commitment has to be unlimited. And, presumably, the higher the level they choose to peg, the more intervention may be required to hold it," said Ray Attrill, senior currency strategist, at BNP Paribas in New York.

The dollar rose 2.0 percent as well to 0.77740 franc, but was 16.7 percent lower on the year and 1.8 percent weaker in the month of August.

The dollar was flat against the yen at 76.820 yen, not far from an all-time low of 76.250 set on EBS in mid-March. Japanese Finance Minister Yoshihiko Noda said on Friday he will consider various options if one-sided moves in the yen continue.

BNP's Attrill said there is a very high risk dollar/yen could break lower given little evidence of coordinated intervention. "Unilateral BoJ intervention would likely struggle to effectively arrest" a sharp fall in the dollar.

The euro was little changed at $1.42489, erasing gains as data showing U.S. consumer sentiment worsened in early August weighed on risk appetite.

Speculative investors have turned bearish on the euro, with net short contracts of 8,273. See <IMM/FX>.

(Additional reporting by Wanfeng Zhou; Editing by Andrew Hay)

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