Swiss franc – aggressive intervention

After many failed attempts to stabilise and weaken the CHF since the start of the financial crisis, the Swiss National Bank (SNB) signalled a shift to a more aggressive and potentially successful policy on 6t September. By announcing that it would no longer tolerate the CHF stronger than 1.20 against the EUR and highlighting that in its opinion the CHF was still overvalued above 1.20, the SNB signalled that it was prepared to intervene in the FX market to sell CHF in unlimited quantities. For such a policy to be successful, investors must believe that the SNB is prepared to allow its foreign exchange reserves and its balance sheet to expand to whatever level is necessary to achieve its goal. This suggests that the SNB and the Swiss government must be prepared to move into unchartered territory in terms of market intervention.

Swiss FX reserves as a percent of Swiss GDP reached a new high of close to 45% in August and there must be an explicit acknowledgement that this could go much higher under certain scenarios. In comparison, Japanese FX reserves reached a peak of just over 20% of GDP in 2007. Although this is a unilateral commitment from the SNB and does not have ERM-type bilateral intervention support from the European Central Bank, the potential for success seems high. The CHF was and still is unequivocally overvalued and evidence is building that currency strength is beginning to exert deflationary forces in Switzerland. Our currency team’s proprietary leading economic indicator for Switzerland has weakened sharply in recent months and latest CPI data has shown a shift to more significant negative inflation prints. This is in contrast to the situation in 2010 and earlier this year, when persistent economic strength undermined the efforts of the SNB to weaken the currency.

What are the wider currency market implications of the SNBs actions?

1. The intervention commitment implies a significant additional liquidity to the financial markets IF stresses continue to encourage CHF buying. This should support risk appetite if the CHF remains the main conduit for safe-haven flows.
2. But, if investors feel that the SNB action is credible, it is possible that new pressure will merely be transmitted to other safe havens and bypasses the CHF.
3. The potential knock-on effect to other safe-haven and overvalued currencies is interesting. There is a danger that the JPY may absorb a greater degree of upward pressure in adverse scenarios if investors view likely CHF gains as limited. The probability of the Japanese authorities intensifying their efforts to limit JPY strength has gone up considerably.