We have raised our expectations for the Swiss franc (CHF). We expected the franc to weaken as the global economy improved – but a number of fundamentals are pointing to appreciation of the currency, and the SNB is intervening less than before. We expect the SNB to constrain the appreciation, but interest-rate hikes on the part of the big central banks must be imminent before the franc is likely to weaken again.
The franc has strengthened nicely
Since mid-December we have seen the franc appreciate nicely against the euro and the Danish krone. Before that, the exchange rate had moved within 3% for a period of about nine months and within 1.5% for a period of about four months! Throughout the period, the central bank, the SNB, intervened in the foreignexchange market, and in principle this did away with all the upside of the franc.
In spite of the missing upside, the franc has not weakened although FX intervention could be seen as a ‘free option’. The fact that the franc has not depreciated is due to a number of factors, the main ones being the lack of appeal of CHF funding (the gain on interest rates being too low compared with the risk of funding in a foreign currency); relatively better economic development (the lesser of two evils); a narrowing of the yield spread between longer-term euro-zone and Swiss bonds; and a surplus on external balances.
The yield spread has long pointed to a stronger franc, but SNB intervention has prevented appreciation. The fact that the SNB has adopted a more open stance on intervention is supportive of a stronger franc.
Switzerland boasts a current-account surplus, so there is a natural demand for Swiss francs.
The basis balance of payments (BBoP) – which includes portfolio investment and foreign direct investment (FDO) besides the current account items – reveals that particularly portfolio investments have benefited the franc.
As will be seen, there are a good many fundamental arguments in favour of a stronger franc. In the spring of 2009, the SNB used fear of deflation as an argument in favour of foreign- exchange intervention, and the latest statements show that inflation is no longer in negative territory. The fact that the SNP steps down invention may therefore relate to the original arguments in favour of implementing the policy. As described later, it may look strange that the central bank reduces intervention so shortly after an interest-rate meeting at which there was no intimation of any change.
