With regards to the Swiss franc, we predominantly forecast EURCHF and then triangulate out our USDCHF calls with the aid of our EURUSD forecasts. We do this for two reasons. First, the Swiss National Bank practically drew a line under the 1.05 level on EURCHF during the height of the pandemic with a series of FX interventions.
Therefore, we look at the EURCHF rate to accommodate potential bouts of intervention from the SNB. Recent commentary by the SNB’s President Thomas Jordan in a lecture for the IMF highlighted this. Jordan stated that currency intervention is an “essential” policy tool for Switzerland given they “cannot lower interest rates indefinitely”. Secondly, with trade largely conducted in EURCHF due to the eurozone being Switzerland’s largest trading partner, the euro-swiss cross is a vital input into the SNB’s inflation outlook, which again determines monetary policy actions. This is, admittedly, a less important dynamic at present with the SNB far from being able to normalise policy with inflation in deflationary territory and the franc still relatively strong. While the SNB’s inflation target is CPI below 2%, similar to the ECB’s, deflation is as undesirable as inflation at or above 2%. With inflation currently in negative territory, substantial franc weakness and a rebound in domestic conditions are necessary for the SNB to start unwinding its current monetary policy framework which acts as a headwind to CHF strength.
Given our bullish stance on the euro due to improving economic conditions and our view that CHF is a more regional risk-off currency, we have lifted our EURCHF forecasts accordingly.
Previous forecasts are in parentheses
PRESSURE ON THE SNB IS SET TO EASE AS EUROPEAN RISK RETREATS
Our EURCHF forecasts continue to show a rally over the coming 12-months, but the latest upwards revision is a reflection of our EURUSD forecasts being upgraded. The reasoning behind our EURUSD forecast hinges predominantly on a faster economic recovery on the continent relative to the US due to effective containment of the initial outbreak and a rigorous fiscal response. With the first wave of the virus effectively contained and the economy broadly re-opening, with the exception of restricted travel plans and localised containment measures, the prospects for a sustained euro rally are strong. Additionally, relative to recent history, the quick consensus by EU leaders over the recovery fund highlights the political will to drag the eurozone economy from the depths of the Q2 recession. While the €750bn is a small fiscal injection in the grand scheme of things, we argue that the signalling effect of greater political and economic integration was a driver of euro strength. Although, it must be noted that downside risks, including further localised outbreaks, still persist to this constructive EUR outlook.
While CHF holds a role as a global haven currency, along with JPY and USD, arguably its haven attributes are stronger when regarding regional risk. With the containment in Europe relatively effective and the economic recovery underway, haven flows are likely to unwind. However, with the SNB buffering market forces at the 1.05 level throughout the crisis, the level of haven flows set to unwind as the economic environment improves is arguably less for CHF relative to other safe havens such as JPY. The improving outlook in Europe will begin to take pressure off of the SNB, however, with much welcome CHF depreciation against major trading partners. This is currently evident with EURCHF trading at the 1.07 level, some 2 points above the level of SNB intervention. Although, the Swiss franc’s strength against the US dollar is another question altogether. While we see CHF depreciation in general on improving risk sentiment globally and in Europe, against the dollar we see the franc trading relatively flat at current levels. This is due to the broad US dollar weakness being factored into our base case for G10 forecasts as per our USD outlook.
Lasting deflationary effects is why the SNB buffers a strong franc, as evidenced by sight deposit data – a EURCHF rally will be warmly welcomed by the central bank as its balance sheet expands
RISKS TO OUR EURCHF CALLS:
- While most of the risks are similar to the risks to our EUR outlook, the main idiosyncratic risk to the franc is the fragility of the SNB’s balance sheet. The consequence to their FX interventions has been a ballooning balance sheet, which has left the central bank as a major market player. The central bank’s balance sheet has been invested in equity markets compared to sterilisation in bond markets, meaning the SNB’s balance sheet is more exposed to risk. With FX investments now sitting above US$80bn, the SNB’s exposure could be enough to derail the Swiss economy. Any extreme or sustained losses to the Bank’s balance sheet could cause the repatriation of funds and therefore further CHF appreciation, along with potential political intervention into the national bank’s workings. We see this as an unlikely, but noteworthy tail risk to our CHF outlook. More realistically, any significant outperformance of the eurozone, due to European growth outstripping other developed markets, could give the SNB room to partially unwind its expanded balance sheet.
- The remainder of the risks are also shared in our EUR outlook. These predominantly focus on more restrained fiscal policy during the latter stages of the eurozone economic recovery and further localised outbreaks leading to a flatter growth trajectory. While a more restrained fiscal stance by European leaders in the latter stages of the recovery will pose downwards risks to our EURCHF forecasts, predominantly due to a weaker EURUSD outlook, it is unlikely to filter through into a broad CHF move sparked by risk aversion. However, an increased number of localised outbreaks could re-introduce haven flows back to the Swiss franc, leading to broader based CHF appreciation. Again, we would expect USDCHF to trade relatively more subdued than EURCHF in this climate as a wider second wave risk in Europe would arguably lead to a stronger dollar at the margin.
- Additionally, with the euro strengthening to multi-year highs during the fragile economic recovery, the European Central Bank may opt to intervene verbally in a similar way to the Reserve Bank of New Zealand. This again poses a downside risk to our EURCHF outlook as another headwind to the euro rally is introduced.
SNB’s balance sheet explodes in latest intervention effort, posing risks to the Swiss economy
Author: Simon Harvey, FX Market Analyst
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