Positions in Europe: Long Germany (EWG); Short Spain (EWP)
Up, Up, and away. That’s the trend move in the CHF-USD over the last decade and CHF-EUR since late 2007. A white hot currency has both advantages and disadvantages from a macro perspective. Typically a strong currency is harmful for exporters; however recent data suggests just the contrary for Swiss exporters. Interestingly, monetary policy from the Swiss National Bank (SNB) to hike benchmark interest rates off the rock-bottom level of 0.25% (since March 2009) has largely been handcuffed due to 1.) low inflation, 2.) mild growth prospects, and 3.) the threat that a rate hike could impose further currency appreciation.
However, recent statements from SNB President Philipp Hildebrand suggest a more hawkish tone on monetary policy. Given the increased likelihood of a intermediate term rate hike and the continued CHF flight to safety trade alongside Eurozone sovereign debt contagion, we’d recommend getting long the CHF-USD (via the etf FXF). Switzerland more broadly can be played with the etf EWL.
Marginal Shift from SNB
SNB President Hildebrand has indicated a growing unease about price pressures, saying that the economy is expanding “more vigorously than anticipated” and “certain upside risks” on inflation “are beginning to emerge.” Further, Vice Chairman Thomas Jordan said that while policy makers are “very concerned” about currency developments, exporters have “coped relatively well” with the franc’s appreciation.
Exports Defy Strong CHF
Quantifying “coping relatively well”, exports rose 9.8% in Q1 year-over-year and +7.9% in April month-over-month, driving a positive trade balance of 1.5 Billion CHF in April.
A recent report from the IMF on Switzerland shows that despite the strength of the CHF, due to the low level of price elasticity of demand from the Eurozone (0.4%), exporters have seen little hit. In contrast, price elasticity of demand is much higher in the emerging market, and therefore in the go-forward there’s a real threat that volumes will be dented. For reference, exports to the Eurozone contribute ~ 60% of total exports, while EM contributes ~ 15%, with the balance going to other advanced economies.
As the chart below shows, exports from Switzerland are diverse; yet the main goods include: chemicals, machinery and transport equipment, and various manufactured goods.
Currency and Interest Rate Risks
We continue to see the pile-in trade to the CHF as Europe’s sovereign debt contagion threats continue to press to the forefront. Managing a strong CHF versus major currencies is after all nothing new to the SNB, which throughout 2009 intervened to depreciate the currency versus the EUR. The bank again intervened (again largely unsuccessfully) from the end of 2009 to mid-2010 to prevent “excessive” appreciation.
Now, a main threat is the credit risks associated with an increase in mortgage lending activities. According to the latest IMF report on the SNB, the abundance of liquidity has increased risk taking, leading to declining lending standards in the mortgage market, especially to less affluent households.
Under the Hood
Fundamentals continue to look solid in Switzerland. Unemployment is at 3.1%, the lowest since February 2009, the KOF leading indicators rose to the highest in almost five years last month and the latest PMI Manufacturing numbers are strong, showing a major inflection from its Eurozone peers which collectively slid in the May numbers (for more see yesterday’s post titled The Big Read: European Manufacturing PMI).
Consensus expects the Swiss economy to expand 2.4% this year and 1.9% in 2012.
We’d expect the CHF to appreciate versus the EUR and USD over the intermediate term as Europe remains mired in sovereign debt contagion (flight to safety) and the US remains unclear on a strategy to tackle its elevated debt and deficit (the debt ceiling debate). While the SNB exchange rate may be more driven by developments in Greece rather than the bank’s monetary policy stance, more hawkish comments on rates by the bank should only further propel the CHF versus the EUR and USD.