This note was originally published May 28, 2013 at 13:54 in Macro
TRADE Call (3 weeks or less): The CHF remains overvalued versus the USD and EUR; expectations that the SNB could shift the floor in the EUR/CHF or cut rates to negative may burn the CHF lower. (etf: FXF)
TREND Call (3 months or more): We’re bullish on the USD versus the CHF as our #StrongDollar remains intact. However, the CHF could strengthen against major currencies if it moves back to “safe-haven” status, especially should we experience another round of sovereign or banking risk scares out of the Eurozone, and/or if the SNB does not cut below 0%.
The Swiss Nation Bank (SNB) meets next on June 20th to discuss its interest rate policy. There’s speculation based on comments from the SNB’s head Thomas Jordan last week that it could implement negative interest rates and shift the floor in the EUR/CHF. [Last Wednesday the EUR/CHF hit 1.2614, the weakest level for the franc since May 2011]. We believe over the immediate term TRADE there’s more weakness in the EUR/CHF and USD/CHF. Beyond the potential policy moves by the SNB, we’ve seen investors pulling assets from the “safe-haven” trade and we remain grounded in our #StrongDollar call.
As we show in the first chart below, beginning in September 2011 (following the CHF appreciating to an all-time high in August) the SNB bought foreign reserves to maintain a floor in the EUR/CHF at 1.20 francs. Since September 2011 the SNB has increased its FX reserves by +125%, and we have reason to believe that the SNB wants to get involved in the global currency war. Both a cut to the 3M target interest rate (currently at 0%) into negative territory, and continued FX buying and/or an adjustment in the EUR/CHF higher could burn the CHF lower versus the EUR and USD, at least over the near term.
In many ways the SNB is in a tough spot to manage the economy. These challenges include:
- Swings in the currency to and from safe-haven status
- Steady deflation
- Low interest rates
The amount of FX buying from the SNB shows just how terrified it is of a strong currency. The worry here is two-fold -- that a strong currency 1.) will cripple export demand and 2.) force domestic companies to lower prices to ward off cheaper imports.
With about 60% of exports destined for the EU, it’s interesting to note that there’s a relatively weak relationship between the overall price of the currency and export demand. Below we show that the correlation between the CHF/EUR and Swiss Exports is +0.41. We think some of the weakness in this correlation can be explained by its basket of export goods, with a heavy mix of pharmaceutical and luxury exports, which command pricing power.
So while rhetorically there might be great emphasis placed on the threat of a strong CHF on exports, we do not think it holds up.
On deflation, Switzerland has been hit by a steady level of deflation since late 2011, with CPI falling for 19th straight months (currently at 0.40% Y/Y). We believe that while Switzerland has benefitted from falling energy prices from a stronger USD, the Bank wrestles with its policy to promote inflation. It fears that under an environment of steady deflation consumers will put off purchasing, assuming prices will go lower in the future.
So, while the Bank is hardly worried about stoking inflation with a rate cut, it’s aware of the policy risks around cutting from 0%:
- further taxing savers
- stoking a mortgage and housing bubble
- chasing away safe-haven assets
- no ability to guarantee that negative rates will incentivize banks to increase lending
While we’ve yet to see signs of a dangerous expansion in the mortgage and housing market (the SNB cut to 0% in August 2011), this threat remains on the minds of policy makers. We’re also seeing investors park less of their assets in Francs or Franc-denominated assets as the risk climate in the Eurozone improves.
One big question mark that remains is the extent to which banks, especially if the SNB cuts to negative rates, increases their lending to seeks a better return on money.
Broader Fundamentals Appear Strong, Relatively
Below is a snapshot of Swiss GDP. Our call-out here is that with GDP low to depressed across much of the region, we think Switzerland’s relative outperformance will continue to anchor a market of strong investment despite low interest rates. A weaker CHF versus its trading partners on the margin will also remain a positive.
Swiss GDP is forecast to rise +1.3% this year versus -0.50% in the Eurozone. With a Swiss budget surplus of +0.3% of GDP in 2012 and debt of 53% of GDP last year, its fiscal house remains in order and could quickly transition back to its safe-haven status should we get another round of sovereign or banking risk scares out of the Eurozone.
Below is a graphic illustrating our levels on USD/CHF via the etf FXF. We outline the intermediate term TREND line that the FXF violated. We view this as a bearish signal and expect weakness into the SNB’s June 20th meeting. Should the bank act, either in cutting rates, and/or adjusting the floor, or setting future expectations for either, we’d expect further weakness.
The Swiss Market Index (SMI) is up 20.5% YTD, leading the pack as the best performing European index YTD. The SMI is up 4.6% MTD and as we outline in the chart below (via the etf EWL), is in a bullish formation.