EURCHF has found itself in the spotlight recently as the pair struggled to break the 1.05 level on renewed commitments by the SNB to intervene “more strongly in the foreign exchange market to contribute to the stabilization of the situation”.
In the current Covid-19 environment, the Swiss franc has seen considerable pressure from safe haven inflows which are unlikely to abate until the global economy starts to show signs of recovery. With the Swiss National Bank (SNB) keen to keep a lid on any serious bout of currency appreciation, due to its impact on domestic inflation and its terms of trade, the central bank has been forced to intervene at a rate that hasn’t been seen since the removal of the EURCHF floor in January 2015.
Domestic sight deposits are the markets best proxy for central bank intervention in FX markets as the SNB only publishes intervention data on an annual basis, usually in its March quarterly policy bulletin. Sight deposits increase when the SNB purchases EUR and USD from banks directly, in effect increasing the amount of CHF in the system which is then parked at the central bank in the form of reserves in the interim. Sight deposits have risen by over CHF10bn 3 times in the last 6 weeks. While some of the increase in sight deposits is due to economic conditions in general, the size of the latest spike is comparable with 2015 and the SNB’s last serious intervention following the exchange rate regime shift. Rough calculations suggest that total CHF deposits have risen more than 2% each day in the past two weeks, a pace which hasn’t been matched in the last 5 years.
Total sight deposits rise at a rate that hasn’t been seen since 2015 as the SNB step up intervention measures
Despite the SNB intervening, and the clear directive given to markets by the weekly sight deposit data, the Swiss franc hasn’t been comfort weakening in the current economic climate. The cross has tried to trade above 1.06 twice since the epidemic hit mainland Europe, both times the move proved short lived as markets defied the SNB’s attempts at weakening the currency.
EURCHF upside may have to wait for improvement in global growth
While the deterioration in risk sentiment has seen inflows into CHF and JPY amid a general flight to safety, this hasn’t been the sole driver in EURCHF heading towards the 1.05 level. Increased liquidity measures in the eurozone, such as the expansion of asset purchases and the TLTRO III facility, has blunted the prospect of a euro rally in the short-term. With the euro likely to remain on the back foot until domestic and global growth conditions improve, the EURCHF cross will likely struggle to find sufficient impetus besides SNB intervention to make a sustainable break above the 1.06 level in the short-run.
This naturally leads to the question of how long the SNB can continue to intervene at present levels? In this circumstance, it is as difficult a question as how long is a bit of string.
Unlike defending against currency depreciation, defending against appreciation doesn’t rely on a stock of foreign currency reserves. In this light, the SNB’s intervention measures are seemingly unbounded. However, in reality the main constraint to such a scenario is its impact on inflation. With the current SNB intervention measures being unsterilized, i.e. not being backed by corresponding sales of assets (usually fixed income instruments) to neutralize the impact on the monetary base, unbounded intervention can easily correspond to rising inflation levels. The latest intervention doesn’t necessarily run this risk in the short-term, with April’s CPI reading sitting deep in deflationary territory at -1.1% YoY, while a strong franc poses further deflationary pressure, but once global conditions do ease it the expansion in the monetary base will likely cause a spike in inflation if not corrected. With this in mind, and a technical rate cut being implemented by the ECB in March when the TLTRO III rate was lowered to 0.25% below the deposit rate, the SNB may prefer to lower rates to defend the 1.05 level.
Taken together, we expect sight deposits to continue to rise in the coming weeks, although at a slower pace than present should economic conditions allow.
Additionally, the probability of the SNB lowering the sight deposit rate has increased given their latest intervention measures have failed to help EURCHF rise comfortably above the 1.06 level and the recent decision to expand the threshold at which negative rates apply from 25 to 30% as of April 1st 2020. With the ECB loosening policy rates at the margin and bank profitability protected, we expect the SNB to lower its policy rate to -0.85% when monetary policy is next reviewed in June. In the interim, it is hard to envisage a structural breakout in EURCHF from the 1.05-1.06 range, with market forces and monetary intervention compressing the range in which the cross trades. However, downside risks prevail in the form of a second wave of coronavirus cases in Europe, or indeed globally, along with the prospect of a further deterioration in US-Sino relations.
EURCHF struggles to break range in current economic environment despite SNB intervention
Author: Simon Harvey, FX Market