Global Outlook: Basle faulty?
Time will tell if the Swiss National bank’s intervention to stop investors flocking to the relative safety of the franc, threatening exports and tourism, will work. Críona Fitzgerald, Head of Corporate FX Investec, reports.
It appears that the whole world has been buying Swiss francs, causing this iron-clad currency to appreciate 43% against the euro since the start of 2010 to August 2011, almost touching parity at one stage. Viewed as a safe haven for investors looking for alternatives to euros, investors flocked to the relative safety of the franc. But how much pain can a country take when that country is very dependent on exports and tourism?
On September 6th, the Swiss National Bank (SNB) took unprecedented action and announced they were going to intervene to “substantially and sustainably” weaken the Swiss franc in a move to defend their currency. In their statement, they said they were “no longer tolerating a EUR/CHF exchange rate below the minimum rate of CHF1.20”. The announcement had its intended result, with one of the biggest daily foreign exchange movements in recent times – within minutes the franc had depreciated by over 8% to the target level of 1.20.
For how long will the SNB defend their currency?
Central Bank intervention does not come without danger as we have seen in the past. In September 1992 on Black Wednesday, the Bank of England had to defend the British pound against George Soros and they depleted their foreign exchange reserves. Over the years the Japanese have intervened to defend their currency with little success. It is a strategy that works in the short-term but longer term proves more difficult to sustain.
The Swiss have a track record of intervening in the markets. In the 1970s, the Swiss were forced to charge depositors and there was a period of negative interest rates. Recently again, the Swiss tried to drive down the value of their currency by money market intervention but this had no impact. The SNB tried a similar action in the 1.40’s range in 2010 which failed and the Swiss franc strengthened substantially to the levels we have recently seen. One does wonder about how effective intervention can be in suppressing the strength of the franc, given the liquidity in the currency and the fact that it is openly traded.
Has the Swiss franc lost its safe-haven status?
The Swiss franc has been a clear favourite as the safe haven for capital flows leaving the euro area. Is it right that the Swiss National bank can defend its currency and in doing so “distort” markets? The euro zone has failed to get its books in order, get agreement on periphery worries, bring back confidence in the euro and as the result the Swiss economy has suffered as funds pile in to what is regarded one of the safest currencies. Investors did not flock to the safety of the franc in expectation of Swiss strength, but rather because of the stability of the country and FX liquidity. The strength of the Swiss was only a bonus and the Swiss franc is likely to remain a fairly safe place.
The problem with Switzerland is its vulnerability to exports and Swiss companies are beginning to suffer as their profit margins get wiped out as a result of the exchange rate move. The big question is how long can these companies can continue until they are forced to move. The currency is still extremely overvalued at 1.20 with many analysts saying a level around 1.35 is more appropriate.
What alternatives are there for investors?
After the Swiss intervention, investors looked to the Norwegian Knona as an alternative play but the Norwegians don’t seem to like it anymore than their Swiss counterparts. Norway has a comparatively thriving economy, which is estimated to expand by 3% in 2011, Europe’s lowest unemployment rate at 2.8%, very low public debt and is on course for a 12.5% budget surplus this year. The Norwegian Krone is appreciating and this will not be good for their economy. Again, similar to Switzerland, a rise in the Krone’s value naturally has quite a few ramifications for Norway, with exporters of Norwegian goods and the tourism sector suffering. Norway saw big flow initially until investors realised there is not the same liquidity in Norwegian Krone as Swiss and as such we believe the Krone cannot function as an effective safe haven.
Will intervention succeed?
The SNB intervention has been seen in the markets as one of the most aggressive policy responses since the financial crisis of 2007. The Swiss franc is still strong in historical terms. The Swiss can print their currency in unlimited amounts for as long as they wish and keep the value of their currency down. However, there may be an inflationary impact to take into consideration at some point. This unconditional expansion of money supply does not come without inflation risks, but maybe not in the short term. Currently, Switzerland does not have an inflation problem. However, bear in mind the SNB could be forced to raise interest rates down the line because of inflationary pressures. Further ahead, Switzerland may have to choose between an interest rate target or exchange rate target, but not both.
The SNB action is credible and they are unlikely to abandon this current course anytime soon. There are clear signs of Swiss strength hurting the economy; therefore politicians will be under pressure to support this intervention. Ongoing pressures from euro zone periphery worries and related safe-haven flows will continue to weigh on the Swiss franc. Whether the central bank intervention will stop investors rushing into Swiss francs remains to be seen. This is certainly a space worth watching in the currency markets but maybe don’t start planning your winter skiing trips to the Swiss Alps just yet.
