The Swiss franc's new paradigm

In much the same manner as the Japanese yen, the Swiss franc now trades according to a completely different paradigm.

Recently, some of the immense safe-haven flows that have poured into the Swissie over the past few years have started to move out in search of higher returns. Some investors now feel less threatened by Europe’s debt crisis, and are shifting a portion of their currency exposure back to the single currency. Also, for the first time in quite a while, the CHF looks like a two-way bet, which makes it more attractive to traders.

EUR/CHF traded above 1.25 overnight for the second time this month. The SNB still regards the CHF as being extremely overvalued, a view reiterated last week by SNB President Jordan. At 1.2460, the real effective exchange rate of the Swiss franc is 9.5% above the 5yr average and 17.7% above the 10yr average, so there is plenty of potential for the Swissie to weaken if these safe-haven flows continue to depart the confederation.

This month’s price action has prompted speculation that the SNB might be tempted to lift the 1.20 EUR/CHF ceiling they imposed in September 2011. For their part, the Swiss National Bank will be delighted by the nature of capital outflows recently. Moreover, with the economy still in the grips of deflation, they would clearly be very happy to see the currency depreciate further. Strategically, policy officials will be weighing up very carefully what (if anything) they should be doing with the ceiling. Into the teeth of a wave of capital inflow, the SNB showed huge mettle 16m ago when they declared their preparedness to buy foreign currencies in unlimited quantities in order to enforce their newly-declared 1.20 ceiling. Therefore, they are clearly prepared to lead the way if necessary, and so it would not be a surprise if they lifted the ceiling to (say) 1.30 reasonably soon. Alternatively, they may simply allow the market to adjust naturally, which would afford the SNB the opportunity to both re-weight and reduce their immense war-chest of currency reserves.

Swiss politicians remain vociferous in their demands for an even weaker currency despite the recent depreciation.
Finance Minister Widmer-Schlumpf told Davos last week that the franc is still much too strong and needed to fall further. She was subsequently backed up a few hours later by Economy Minister Schneider-Ammann. After the success which Japanese politicians have had talking down their currency over recent weeks, their Swiss counterparts may well have decided that they should follow suit.