LONDON: The Swiss franc has scope to weaken to 1.30 against the euro in the first quarter of 2013 as investors' cautious optimism towards the euro zone reduces the franc's appeal as a safe haven.
Huge bets that relied on the franc holding firm were built up as the currency spent month after month pinned near the 1.20 ceiling imposed by the Swiss National Bank since September 2011.
But a marked weakening in the franc in the past week is threatening the profitability of these positions, prompting traders to scale back their franc holdings and generating a scramble for protection in the options market.
These adjustments will take far more than a few days to work through the foreign exchanges, not least because liquidity is sometimes proving to be a problem when large amounts of Swiss francs have to be traded.
And the reasons for the euro to extend its gains against the Swiss franc are still in place.
Investors who bought francs to escape the financial crisis in the euro zone are starting to wonder whether they should be seeking higher returns elsewhere given the European Central Bank's stance.
The creation of the ECB's Outright Monetary Transactions (OMT) bond-buying programme has helped to drive down periphery bond yields, even though the programme has yet to be activated.
And ECB President Mario Draghi helped reassure investors further after he announced a unanimous decision to keep the central bank's benchmark rate unchanged on Jan. 11.
Investors noticed that Draghi also alluded to lower periphery bond yields and a tightening in credit default swaps as evidence of "positive contagion".
And while the franc may be sliding away from the SNB-imposed ceiling, there is little reason for the central bank to do, or say, anything to halt the move.
A central bank which has made such a foreign exchange commitment is likely to see the four percent move from 1.20 to 1.25 as a battle won, but not as an unconditional surrender by markets which have been betting on Swiss franc strength.
Moreover, the euro's rise so far has not been pronounced from Swiss exporters' point of view since even an exchange rate of 1.40 would be relatively strong in the context of how the franc has traded in the past decade or two.
Even more importantly, any hint that the SNB might be willing to sell euros for francs could prompt another assault on the 1.20 ceiling.
This is the last thing the SNB would want to encourage given recent data. For example, Swiss industrial orders fell 0.7 percent in the third quarter of 2012 compared with a year earlier, extending its second quarter drop.
Additionally, Swiss consumer prices fell in December, reinforcing the SNB's case for maintaining a cap on Swiss franc strength against the euro.
By contrast, if the euro were to start approaching 1.30 francs, international investors who bought franc-denominated assets in the past year might consider bailing out of these positions to limit their losses.
That would fuel an even more pronounced slide in the Swiss currency.
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