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 SNB’s balance sheet not as favourable as in 1978 As a consequence of last year’s failed intervention, the SNB’s balance sheet is not as strong as it was in 1978. This implies that the Swiss monetary authorities have less room for manoeuvering on the intervention front. Indeed, in 1978, the SNB’s balance sheet to GDP ratio stood at 23%, with the FX reserves to GDP ratio at 12%. Meanwhile, at this point, the current balance sheet and FX reserves to GDP ratios stand at a high 46% and 35% respectively.

The SNB’s provisions can absorb another CHF20bn in losses. Beyond that, the insolvency risk soars. However, the SNB has also specified that further book losses or even negative equity are not necessarily a major issue given that liabilities are in CHF and they can print CHF.

It should also be noted that Switzerland’s current account surplus to GDP ratio stood at just 2.4% of GDP in 1978. It now stands at 14%. Finally, unlike in 1978, there is still an uncertain volume of CHF trades that could unwind in the future.

   – 1.20 is a reasonable ceiling target

The actual ceiling level will obviously prove very important to the SNB’s overall policy success. Indeed, by picking a ceiling that is ‘close’ enough to the recent EUR/CHF spot trading levels, the SNB’s task is made easier. Moreover, considering that EUR/CHF fair value is estimated being close to 1.45, a 1.20 rate represents a still highly overvalued currency, giving more ground to justify selling the currency. 1.20 is also still well below the recent two-year moving average (at 1.3570).

In this respect, there has been market talk/rumour that the SNB could adjust the ceiling to the upside in the next few months. We believe that this would be a risky it may be a feasible option over the longer-term: if the ceiling is comfortably respected at 1.20, the SNB may see the logic of targeting a more ambitious level. The SNB has gained credibility but can it keep it up?

While last year’s SNB FX intervention proved to have a very short-lived market impact and was very expensive,the Swiss monetary authorities have gained credibility most recently. The aggressive injection in money market liquidity since the beginning of August has had a significant impact on the currency and so did the ceiling announcement. EUR/CHF rallied nearly 10 big figures and has now stabilized above 1.20.

So far, the SNB has managed to keep EUR/CHF above 1.20 but the deterioration of the eurozone debt crisis in the past few days could not have come at a worse time. Indeed, longer-term, the real challenge for the SNB would arise should the eurozone debt crisis deteriorate much further and lead to global deleveraging with associated aggressive euro selling across the board. This is the time when the market would test the SNB, with the risk of safehaven trades into the Swiss franc resurfacing. It should also be noted that the pre-existing short-base in CHF and the likely unwind of funding positions represent continued bullish forces for the CHF longer-term.

Considering all these remarks, we conclude that for those that have entered short EUR/CHF positions earlier this year (at 1.25-1.30), we recommend staying short. The ceiling is unlikely to lead to a trend reversal, unless the eurozone position was to improve substantially. For new money looking to play the safe-haven trade, gold and the JPY appear to be more viable alternatives.