Since the December forecasts, our EURCHF one-month forecast of 1.085 has practically been reached with EURCHF currently trading at 1.084. However, since the last forecast round, our EURUSD forecasts have been revised up to account for the earlier than expected bout of dollar weakness seen in markets – this will be represented in our January forecast document. Additionally, we have brought forward the previous EURCHF forecasts to also represent our expectations of a more aggressive euro rally in the first half of the year than previously expected – the previous 3-month forecast is now the 1-month forecast etc. Triangulating the EURUSD and EURCHF forecasts, this results in USDCHF stability over the coming 12-months, with the dollar strengthening marginally against the franc in the second half of 2021.
January forecasts for CHF see our EURCHF forecasts brought forward from December’s projections
* December’s forecasts are included in parentheses
EURCHF IS MORE IMPORTANT FOR SWITZERLAND’S STRUGGLING INFLATION OUTLOOK, BUT USDCHF DRAWS SOME ATTENTION AFTER THE TREASURY REPORT
With Switzerland importing $98,682.3m worth of goods from Germany, Italy and France relative to $18,823.9m from the US, the EURCHF exchange rate is substantially more important for the SNB to monitor for inflationary purposes than USDCHF. Sight deposits, a timely proxy of SNB intervention as the central bank credits the sight deposit accounts of commercial banks with newly created CHF in exchange for foreign currency, have dramatically risen over the last year as EURCHF fell close to the 1.05 level. While the SNB doesn’t target exchange rate levels explicitly, the rise in sight deposits as the EURCHF rate tested the 1.05 level sent a clear message to markets of where the central bank’s tolerance level is. Ultimately, the SNB’s intervention efforts proved effective in protecting the 1.05 level, however, the franc is yet to substantially weaken and promote inflationary forces again in Switzerland as it trades only 3% weaker at the time of writing compared to May’s highs of 1.05.
SNB intervention signalled by rising sight deposits in the first half of 2020 as the EURCHF rate places increasing downwards pressure on the inflationary channel as it drives to the 1.05 level
While we expect this broad trend of EURCHF appreciation to continue, helping inflation in Switzerland return back to 0% where the central bank expects it to remain for the coming 2-years, the main dynamic in play will be broad EUR appreciation as global economic conditions and eurozone growth support the pro-cyclical currency. If our forecasts of the EURCHF rate are realised, we expect the SNB to reduce its efforts in FX markets, similar to that seen in December 2020. For the USDCHF rate, we expect the recent trend of slight CHF appreciation to continue on the back of broad dollar depreciation as outlined in our USD outlook, especially in the first half of next year. In the second half of the year, however, we expect the Swiss franc to underperform against the dollar as the broad dollar downturn starts to stabilise; this should help ease the pressure on the SNB after its latest intervention measures drew the attention of the US Treasury Department.
SNB expects mild inflationary forces but enough to drag CPI out of deflationary territory
Source: Swiss National Bank, Bloomberg
In the first half of 2020, the SNB’s intervention in FX markets resulted in the US Treasury Department labelling the country an “FX manipulator” along with Vietnam in December’s report. While the title is more symbolic than anything, and may even be reversed under President elect Biden’s leadership, it reinforces our belief that the SNB will wind down interventionist practices in 2021 conditional on market forces allowing them to. By being labelled an “FX manipulator”, the US Treasury deems Switzerland to have manipulated its currency for the purpose of gaining an international trade advantage or adjusting their balance of payments, thus triggering Section 3004 of the Omnibus Trade and Competitiveness Act of 1998. In addition to this, Switzerland, along with Vietnam, also breached Section 701 of the Trade Facilitation and Trade Enforcement Act of 2015, which has three more specific criteria for assessment, which include; a material current account surplus, a significant bilateral trade surplus with the US, and persistent one-sided FX intervention. This was the first time a country has met all three criteria of the 2015 Act. While this is likely to lead to trade negotiations between the two countries over the coming year, before any punitive action is embarked upon, the reduction in SNB activity should be sufficient to remove Switzerland from the list as the Treasuries assessment was that their “foreign exchange intervention” was only “for purposes of preventing effective balance of payment adjustments”.
USDCHF shows franc appreciation throughout 2020 as SNB focus sits squarely on the EURCHF rate
While this may be true in regards to the EURCHF rate, where most of the SNB’s FX interventions took place to combat deflationary forces, it is less clear in the USDCHF rate. Beyond Switzerland having a trade surplus with the US, the SNB’s lack of intervention resulted in the franc strengthening over 8% against the US dollar this year – a dynamic that should chip away at this surplus over time. Additionally, the US still runs a services surplus with Switzerland, which is arguably less elastic to exchange rate dynamics. This suggests that our forecasts of relative stability in the USDCHF rate shouldn’t stoke tensions any further between the two nations, with all of the emphasis resting on the EURCHF rate. Furthermore, the transition between Treasury Secretary Steven Mnuchin and incoming nominee Janet Yellen may result in Switzerland being downgraded to the monitoring list. However, risks to this outlook remain. SNB Governor Thomas Jordan quickly responded to the Treasury report in the central bank’s December meeting. Jordan stated that other monetary stimuli aren’t effective in Switzerland’s economy as deepening negative rates beyond -0.75% impacts the profitability of domestic banks, while the domestic bond market remains too small for an effective QE programme. This suggests that an increase in European risk could result in another wave of EURCHF weakness, which would be met with SNB intervention should the drop be rapid enough to alter the inflation projections. This could increase bilateral tensions between the US and Switzerland in the coming months, with the effects on the franc ambiguous. On the one hand, isolated risk to Switzerland’s economy from punitive sanctions by the US could result in CHF weakness, however, being a regional safe haven, the increase in risk could in fact prompt further CHF appreciation which would only exacerbate the situation. We don’t envisage this as a likely scenario to occur in 2021, however, it must be noted as a potential tail risk to our CHF outlook. Even if such a scenario was to occur, the SNB could rebuff market forces flowing into CHF by cutting rates further into negative territory as opposed to increasing sight deposits. While displaying a lack of appetite for taking this option in 2020, the SNB hasn’t ruled out lowering rates further. The US Treasury’s focus on the Swiss central bank may prompt this to be a more likely avenue to offset CHF appreciation in the coming year.
Author: Simon Harvey, FX Market Analyst