The Swiss franc currently sits at a 5-year high against the euro on the back of increased global demand for heaven assets triggered by fears of recessions occurring globally.
The SNB is prone to defending the exchange rate since the Swiss economy is purely reliant in the export sector and the coronavirus shock is set to dampen global demand to a large scale already. With this in mind, EURCHF hitting parity poses a big risk to the Swiss economy but remains a tail-risk at present. Despite holding the lowest interest rate in the world along with Denmark at -0.75%, there are still policy options on the table for the SNB such as FX intervention, swap offering and balance sheet expansion.
Direct intervention in FX markets has been common practice for the SNB and we think this will be the first line of action by the central bank in order to contain further appreciation in the currency.
Sight deposit data suggests the speed of FX purchases has been more aggressive since the coronavirus outbreak in China in mid-January, around the time when the currency broke the 1.08 support on the back of increased safe heaven demand. After the US Treasury included the SNB in the currency manipulators watchlist, the extent to which this tool can run may be tapped, especially in a context of scarce USD liquidity. In turn, the SNB can divert towards ensuring short-term USD liquidity in the form of repo operations aimed at keeping funding conditions balanced.
Both the SNB and the ECB recently engaged in swap lines with the Federal Reserve to help pump more dollars into their economies, and this would be a potentially effective mechanism to wipe out some CHF demand. The SNB has already released a weekly calendar of 7-days and 84-days Open Market Operations, while the ECB did the same.
An interest rate cut could arguably be a tool to consider at the moment given its limited effect in stimulating the economy at this stance and the impending risks of deepening into further negative territory –namely, further profit stress in the banking system. Instead, the SNB is likely to follow suit with ECB’s guidelines and facilitate long-term lending conditions through asset purchases and/or long-term loan programs. Another policy choice before cutting interest rates could be to lower the size of bank reserves exempt from negative rates in an attempt to spur bank lending, but this could be less desirable in terms of domestic financial stability.
Since the dynamics of the exchange rate are rather more concerning for the SNB at the moment while barriers for interest rate cuts are higher, monetary policy will likely focus on facilitating appropriate short-term funding and preventing further currency appreciation via FX interventions.
The SNB might also urge banks into helping channeling fiscal loans to SMEs since the government announced plans of up to CHF 580 million in emergency loans to hit companies. However, we consider that the pressure on SNB to act preemptively is rather smaller with respect to other central banks, meaning it is more likely to delay its policy response.
Inter-meeting announcements could not be ruled out though, since SNB’s unusual schedule is currently set on a quarterly basis. The main signal for sudden action will come in the form of mounting downside pressure on EURCHF.
FX interventions still remain the most likely candidate of action in the SNB’s toolkit.
Author: Olivia Alvarez Mendez, FX Market Analyst at Monex Europe.