LONDON (Reuters) - Investors are betting the Swiss franc is in for a sustained period of weakness against the euro as worries about the debt crisis wane, sapping demand for a currency seen as a shelter in turbulent times.
In a trend likely to be welcomed by the central bank, the franc fell to its lowest against the euro in 13 months on Tuesday. Losses accelerated after European Central Bank chief Mario Draghi last week dashed expectations of an interest rate cut in the near term and said financial conditions in the euro area had improved.
The euro rose to 1.2390 francs on Tuesday, up 2.6 percent this year and a sharp turnaround from a 0.7 percent 2012 loss.
The pair had until recently traded in a very tight range since the Swiss National Bank imposed a cap on the franc at 1.20 per euro in September 2011 to stop the export-driven economy from sliding in a recession.
Throughout much of 2012, with the euro zone crisis raging, the central bank intervened regularly to prevent the franc strengthening.
All that has changed.
"We expect the euro/Swiss franc at 1.24 francs in 12 months, although given the way it is going, it will easily overshoot that forecast," said Marcus Hettinger, FX strategist at Credit Suisse, Zurich. "Risk appetite is improving and there is less demand for the safe-haven Swiss franc."
The drop in the franc has led to increased demand for hedging in the options market against further weakness in the currency. This has resulted in a sharp rise in the cost of betting on further euro gains against the franc.
One-month implied volatility, reflecting demand to buy options giving investors the right to buy euros against francs at a set time in the future, has risen to 6.1 percent from around 2 percent before the ECB rate decision on Thursday.
"Not many had positioned for this move in the euro/Swiss franc spot," said a chief options trader at a large European bank in London. "As a result, implied volatilities have exploded," he said, adding bets are being laid for the euro to rise to 1.25 francs in the next six months.
Risk reversals, a measure of the relative demand for options on the euro rising or falling against the franc, are showing a bias for euro gains in the near term, having barely moved for most of last year.
More significantly, one-year risk reversals are turning in favor of the euro, indicating that the Swiss franc's weakness could be prolonged.
The one-month euro/Swiss franc risk reversal was traded at a premium of 2.5 vols in favor of a stronger euro on Tuesday, rising from around 1.4 at the start of the week. One-year risk reversals have fallen sharply, showing only a marginal bias for euro weakness and could flip to reflect euro strength soon.
"Risk reversals haven't been this skewed in favor of euro calls in the last 10 years," Kit Juckes, currency strategist at Societe Generale said in a note. "The SNB has won its battle, for now."
UNWINDING LONG SWISS BETS
The Swiss franc has long been a favorite among investors seeking safety from the euro zone debt crisis much to the discomfort of the SNB. The franc's strength raised worries that the Swiss economy could slide into recession, forcing the SNB to impose the cap.
Analysts said the SNB would be happy with the latest weakening trend and decrease pressure on it to intervene.
Many speculators and hedge funds have already unwound bets in favor of the franc and some analysts said this could herald a period of sustained weakness akin to that in the Japanese yen.
In October, when the dollar began its ascent against the yen on expectations of easier monetary policy, it rose 2.3 percent before gathering pace and jumping more 5 percent in December.
"The recent move in euro/Swiss franc is starting to resemble that of the dollar/yen move in its infancy a few months ago," strategists at UBS said in a note summing up the Swiss bank's client flows.
(Editing by Nigel Stephenson)
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