Delving into Swiss Franc Rallly & Debt Drama

US dollar didnt get the walloping some expected (or would like) on Monday despite slow progress in debt ceiling talks. The one exception was the Swiss franc which shot higher across the board on risk aversion. Debt ceiling talks will continue to dominate in early Asian trading. More detailed analysis on CHF below.

Two debt ceiling plans were unveiled on Monday: 1) Senate Democrats proposed $2.7 trillion in savings over 10 years with nearly half coming from defense spending cuts. 2) House Republicans called for a two-part plan that would raise the ceiling $1 trillion this year and $1.6 trillion next with even larger spending cuts. The second tranche would require $1.8 trillion in cuts to Social Security, Medicare and other entitlements.

From this it looks like tax hikes (and tax reform) are less likely. Its seems its just a matter of how much to cut and where but Bill Gross prediction that most cuts will be fiction and swamped by lower revenues is already ringing true.

What is also becoming increasingly clear is that this will not be a long-term solution. At best the ceiling will be raised until slightly beyond the 2012 election with very little meaningful reform to entitlements or a credible plan toward a sustainable debt load. This sounds to us like precisely the type of outcome that WILL RESULT IN A DOWNGRADE. If such a deal is announced, we dont expect a downgrade immediately but it will not be advisable to hold USD because a downgrade could be announced at any time. We will have more about the impacts of a downgrade and potential trades in the days ahead.

The dollar would like have fallen farther but the idea that AUG. 2 ISNT THE REAL DEADLINE as taken hold. S&P said the Treasury can stretch out the process beyond Aug. 11. Others say as long as Aug. 15.

Obama is scheduled to speak at 9 p.m. ET (1 a.m. GMT). The chief risk we see here is that Obama abandons his demand that the higher ceiling runs through the 2012 elections. This would probably pave the way for the outline of a deal sometime in the subsequent 48 hours.

Outside of the huge moves in CHF on Monday the forex market was tame. JPY and CAD were mild outperformers with GBP lagging. Gold gapped $14 higher at the open, ran as high as $1621 and closed at $1614. The S&P 500 fell 0.6% to 1337.

Ashraf has six trades open for Premium members and five made gains today. Crude oil shorts are now closed as they hit all targets early in North American trading.

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MORE ON THE SWISS FRANC RALLY

USD/CHF fell as low as 0.8020 on Monday while EUR/CHF remains about 180 pips above the record low of 1.1404.

The reasons for the CHF move: 1) Over the past several weeks some large operations shifted into USD/CHF longs. They were likely stopped out. 2) Technical selling on the break below the record low of 0.8081. 3) The market is pricing in a US downgrade and when the headline hits, the place you want to be is short USD/CHF.

The collision of these three factors today caused an outsized gain in CHF. To us, this move looks like it has gone too far, too fast. Momentum indicators are stretched and consolidation looks more likely in the next few days than declines below 80.00 especially with the risk of a debt deal.