Fighting against the tide of global investors in search of a safe haven could get very costly very quickly for the SNB
The Swiss National Bank (SNB), in a forceful announcement Tuesday morning, signalled its determination to cap the Swiss franc at 1.20 per euro, triggering a steep drop in the Swiss currency. The bold action should help Swiss exporters struggling with an extremely uncompetitive currency. However, fighting against the tide of global investors in search of a safe haven could get very costly very quickly for the SNB.
In its press release, the SNB said that “with immediate effect, it will no longer tolerate a euro-Swiss franc exchange rate below the minimum rate of 1.20 Swiss francs”. Furthermore, the SNB said it would “enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities”. The announcement comes after a week during which the Swiss franc strengthened from close to 1.20 per euro to 1.10. It follows the SNB’s previous statement at the beginning of August that it would intervene to curb its “massively overvalued” currency. The central bank also noted in its announcement today that, even at 1.20, the Swiss franc was still too high.
In our 8 August Daily Theme, we elaborated on the options the SNB had to weaken the Swiss franc. Back then our view was that the most effective way to do so “would probably be to set something like a cross-rate target” – this is what now has been introduced.
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To make this clear, today’s announcement is not a peg to the euro, but an introduction of a minimum rate (the lower the rate of Swiss francs per euro, the stronger the Swiss franc). Therefore, the Swiss franc could weaken further. However, we think this is unlikely in the current environment of extreme risk aversion and continuing uncertainty around the sustainability of sovereign debt levels in developed countries. We believe that the Swiss franc will remain in demand because of its status as a safe haven, but this time the SNB will simply balance out this demand by providing additional supply.
The exporter-dominated Swiss equity market rallied strongly after today’s SNB announcement. But we believe significant further weakness in the Swiss franc would be needed to provide a more durable boost to exports and the economy in general.
Back in March we noted that a strong and strengthening currency would harm exports and therefore companies’ earnings. After markets discounted this in the course of the first half of the year, Swiss equities have outperformed in the recent market turmoil, due to the defensive character of some of the underlying companies (Nestlé, Novartis, Roche). While our view on the Swiss equity market turned slightly more positive at the beginning of August, we don’t expect a continued outperformance from here.
Halting the rise of the Swiss franc certainly helps going forward, but our analysis suggests that it takes about two years for currency moves to have a significant impact on export volumes. To put this into context, the Swiss franc was trading at about 1.50 per euro back in September 2009. A level of 1.20, as supported by the SNB, is a significant 20% stronger with the obvious negative impact on exports.
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Implications for Swiss bonds are more straightforward. With the SNB theoretically “printing” Swiss francs into infinity, yields will remain extremely low (negative at the short end). This will only change when risk aversion decreases, i.e. sovereign debt problems in the developed world are solved and economic growth prospects are improving. We don’t see this happening in the immediate future. While a surging money supply poses an inflationary risk, we don’t see this as an immediate threat given the extremely low level of inflation at present and the fact that additional money supply is primarily used as a store of value by foreign investors (safe haven) but not for inflation-creating consumption.
We believe the bold action the SNB is taking should help Swiss exports of goods and services and should ultimately support economic growth. That said, we are aware that this exercise can become very costly very quickly. But the SNB was clear in saying that they will cap the appreciation of the Swiss franc with the “utmost determination”. We would therefore not expect the Swiss franc to appreciate beyond the 1.20 level in the coming weeks, nor do we forecast any further weakness. This means a range-bound trading environment, with potential for good short-term trading opportunities.
