Currency wars are here, argue Audrey Childe-Freeman and Cesar Perez of JPM Private Bank


At a time when prospects for the world economy have deteriorated significantly and with policy makers running out of ammunition, currency trends have become increasingly important. In fact, it may be argued that we have re-entered a ‘currency war zone' write Audrey Childe-Freeman and Cesar Perez (pictured)

The resurgence of the bullish Swiss franc trend started in June 2010. It must be seen in the context of a multi-year structurally bearish USD trend, in a world running out of safe-haven currencies. Indeed, the USD (up until very recently) has clearly lost appeal, but so has the euro in the past 18 months. The deteriorating eurozone debt crisis is central in explaining the Swiss franc’s gains over that period. For those investors seeking to play the ‘safehaven’ trade and ruling out the USD and the euro, the Swiss franc (and the yen) has become the ‘only safe bet’.

The increased safe-haven status of the Swiss franc is also well captured by the significant increase in the Swiss franc/gold correlation (year to date). Since the beginning of the year and on a daily basis, the correlation between USD/CHF and gold prices stand at 90% (Bloomberg).

Background information on the Swiss National Bank

SNB is a private organization, 62% owned by the cantons & cantonal banks and the rest by thousands of small private shareholders. The SNB’s stock (quoted on the market) is held in majority by Switzerland’s 26 cantons, with capped voting rights.

The SNB is independent and excercises its role with limited intervention from its shareholders. Until last year – when the SNB endured significant FX losses – the SNB has traditionally been profitable. In particular, its large gold holdings (as of June 2011, gold represented roughly 17% of total assets) have been highly profitable over the past couple of years. SNB posted a CHF10.8bn loss on its reserves so far this year (ytd, June 2011), with its equity capital and loan loss provisions dropping from a peak of more than CHF65bn in 2007 to 29bn this June.

SNB foreign currency reserves have been on the rise over the past couple of years, rising more than five fold to over $200bn when the central bank intervened from March 2009 to May 2010. While the composition of its balance sheet is primarily in AAA Government bonds, the flow isn’t FX hedged, and therefore has direct implications for currency markets. When it comes to actual FX reserves diversification, the current mix is 55% EUR, 25% USD, 10% JPY, 4% CAD, 3% GBP and 3% others.

Following the 2010 intervention rounds, there was a diversification, but with a lag, and given the relatively small proportion of USD, the impact on EUR/USD was muted. Bearing this in mind, expect the EUR/USD impact of SNB interventions to be limited this year. There is also an intuitive argument that the SNB is unlikely to try and push EUR/CHF above 1.20 and indirectly weaken the euro by selling EUR/USD as part of a diversification process.

Swiss franc is still highly overvalued

Since the beginning of the year, the Swiss franc is up across the board, against both G10 and EM currencies: as much as 15% versus the USD and 8.2% against the euro.

This adds onto a 9.2% and 15.7% CHF appreciation versus the USD and the euro respectively in 2010 and leaves the Swiss currency highly overvalued. In fact, according to the OECD, the Swiss franc is roughly 43% overvalued versus the euro. Valuation considerations are clearly overstretched at current levels.

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