Markets unwilling to extend the risk aversion trade beyond short-term parameters ahead of Friday’s European bank stress tests

New record lows in US 2-year yields (0.56%) have provided boosted yen’s safe have status, but the Swiss franc stands to reap fresh gains as Japanese officials make themselves heard

CHF has been the second biggest performer over the last 4 weeks

Markets showed the obligatory sell-off to Bernanke’s “Unusually Uncertain” outlook for the US economy, but are unwilling to extend the risk aversion trade beyond short- term parameters ahead of Friday’s European bank stress tests. These parameters represent $1.2740 in EURUSD, 1,050 in S&P500 and $75.70 in US crude oil.

New record lows in US 2-year yields (0.56%) have provided boosted yen’s safe have status, but the Swiss franc stands to reap fresh gains as Japanese officials make themselves heard.

With US 10-year yields falling to 2.85%, the means the US yield advantage relative to German yields shrank to 26 bps, a fresh 7-month low. Further narrowing of the US-GE yield spread will be based on prolonged retreat in US indicators and the affirmation of the “extended period” of exceptionally low US interest rates. Barring any negative developments on the Eurozone banking front, EURUSD remains on track to retest $1.3030 for a follow-up towards the $1.3130-40 target.

Much ink has been justifiably spilled on the yen’s continued outperformance of major currencies during the latest round of risk aversion, but the Swiss franc remains very much in the picture. Out of 36 currencies (G10 and EM), CHF has been the second biggest performer over the last 4 weeks (behind Czech Krona). The combination of falling global bond yields with Eurozone banking uncertainty and US economic data deterioration is likely to maintain the franc’s shine.

Highly publicized reports of the Swiss National Bank’s escalating losses to intervene in FX markets may not prevent the central bank from stepping in again, but any fresh buying is unlikely to stem the tide of safe haven flows resulting from the aforementioned uncertainties. Japanese officials’ growing vocal FX concerns will only slow the pace of the yen’s gains, but is highlighting the franc’s allure as a more lasting safe-haven alternative—beyond bouts of risk aversion.

EURCHF recovery faces pressure at 1.3450-60 given negative cross-over in daily stochastics, suggesting $1.3270 to emerge as interim support, followed by 1.3150. EURCHF shorts are seen emerging as a hedge to long EURUSD positions, which is inherently a short in USDCHF. The pair is down 11% from the June high and is vulnerable to prolonged downside towards 1.0350, a break of which to call up 1.0170. Such scenario will be especially driven by falling US 2-year yields below 0.55.