CHF: A quiet retreat? – Rabobank

Since the spring the CHF has lost around 9% vs. the EUR and more remarkably, the value of the CHF vs. the EUR and Swiss effective trade indices have now shaken off the bulk of the surge suffered in January 2015 when the SNB suddenly walked away from protecting a floor EUR/CHF1.20, explains Jane Foley, Senior FX Strategist at Rabobank.  

Key Quotes

“The motivation for this year’s uptrend in EUR/CHF stems from the broad based rotation back into the EUR led by the improvement in Eurozone fundamentals.  The combination of strong growth, low rates and relatively stable politics in the Eurozone means that from an investors’ perspective this could be as good as it gets.  This has given the SNB’s loose monetary policy settings more leverage and suggests that finally there is a chance that the EUR/CHF exchange rate can move towards more ‘normal’ levels.”  

“For years, the SNB has been fighting against CHF strength, which stems from its status as a safe haven.  We have frequently argued that on paper the CHF is the best safe haven currency.  Switzerland maintains a strong current account surplus (9.8% of GDP in 2016) and a budget which is almost in balance.  Last year’s Switzerland registered a budget deficit of just -0.3% of GDP which is forecast to pop back into balance this year.  Crucially, there are also good levels of liquidity in the CHF and a stable system of law and government.”

“The strength of Switzerland’s fundamentals, combined with its geographical position close to the Eurozone but outside of the EU has, however, often been the thorn in the SNB side.  In recent years, SNB policies have been unashamedly aimed as chasing away safe haven demand for the CHF.  Flows into the CHF accelerated in the 2008 to 2011 period on the back of the global financial and Eurozone debt crises.  The strength of the CHF has resulted in it being significantly overvalued vs. the EUR and most other currencies for a prolonged period.  Although this year’s slippage in the CHF has eased this position on many measures, according to the OECD’s calculation of Purchasing Power Parity, the CHF is still 42% overvalued vs the EUR.”  

“One of most obvious consequences of an overvalued currency is a low inflation rate.  Swiss CPI inflation has not been above the 2% y/y level since 2008; and that was only a short-lived flurry.  That said, CPI inflation has been trending higher from a -1.4% y/y low in 2015.  The 0.7% y/y reading in October was the highest level since 2011.  There is clearly a long way to go before CPI inflation is sustainably returned to levels consistent with the SNB’s price stability mandate. The SNB’s forecasts for CPI inflation in 2018 and 2019 are just 0.4% y/y and 1.1% y/y respectively.”

“In its September monetary policy assessment, the SNB referred to the domestic economic recovery as ‘moderate’ and forecasts growth of just under 1.0% in the current year owing to slow growth in H1 2017.   Although October readings of manufacturing activity strengthened more than expected, real retail sales in October unexpectedly slipped -0.4% y/y.  The sluggishness of consumption growth combined with continued slack inflation provides the SNB with good reason to lag the efforts of the ECB to normalise monetary policy settings going forward.  The SNB’s next policy assessment is scheduled for December 14.”

“Although this year’s weakening in the value of the CHF will have come as a relief to policy makers, we would expect that it is too early for the SNB to change tack.  In an effort to keep EUR/CHF trending higher we would expect the SNB to lag the ECB’s efforts towards policy normalisation going forward.  This implies that the SNB is likely to maintain its negative interest rate and its threat of using FX intervention to undermine the value of the CHF.”

“We expect EUR/CHF to trend up to the 1.18 area on a 6 mth view and to test the 1.20 area towards the end of next year.  These forecasts, however, assume that risk appetite remains strong and Eurozone fundamentals remain attractive.”