04 October 2011
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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)
Other currency implications of the accouncement: one less safe-haven currency
In a world that was already very short of safe-haven currencies (with the euro clearly not inspiring confidence), the SNB announcement leaves the JPY and gold even more isolated.
Furthermore, while the August FX price action had raised serious question marks over the USD longer-term safehaven status, the September price action suggests that the USD may be safe after all. It may also be argued that the SNB ceiling announcement helped USD bulls at the margin. The USD trade weighted index has gained roughly 4.5% so far in September (as per Sept 12th). We are also of the opinion that a further eurozone crisis deterioration and lack of adequate response (in the form of a move towards fiscal union) risks to favour further deleveraging, leaving the USD much better positioned in the near-term.
In a ‘new safe-haven currency world’, the Norwegian krone is in good shape, for now. A still healthy fundamental background, supportive monetary policy outlook and supportive structural forces (current account and fiscal surpluses expected at 11.9% and 10.6% of GDP ratio), are all positive for the Norwegian krone. However, at a time when the world economy is going through a marked deterioration in activity, monetary authorities have and will most likely continue to show less tolerance with regards to exchange rate levels. This is a risk that cannot be ignored and that could spoil krone bull positions should the krone appreciate ‘too quick, too far’.
Another risk to bullish krone positions is the euro. Even though Norway is actually not even within the European Union, a global deleveraging and pronounced euro weakness/worry over plausible euro disintegration would not spare the krone. Considering this, we prefer bullish NOK positions versus the EUR than versus the USD at this stage.
In Asia, the Singapore dollar and to some extent the CNY are looking all the more appealing in the current context.
We also note that it is premature to completely cross out the Swiss currency as as safe-have play. We are of the view that as long as global uncertainties persevere, the SNB introduction of a ceiling will stabilize EUR/CHF but it is unlikely to reverse the trend. So this may not be the time to be an outright Swiss bear. We are neutral over the medium-term. Indeed, whether 2012 eventually proves to be a bullish or a bearish year for the CHF, it is arguably more a function of eurozone developments than of the SNB policies.
Conclusion
The peg option had been talked about in FX circles, but no one really believed in it just yet, so the SNB’s ceiling announcement was not a total shock, but the timing was arguably a surprise. The impact on the Swiss franc was significant, with EUR/CHF jumping to a high 1.2191 shortly after the announcement.
Whether the SNB’s strategy can prove successful in the long-run and reverse the past two years’ Swiss franc strength remains open to debate. In fact, we are of the view that the best the SNB can hope for is an improvement on the international/macro/market context. In this respect, the latest deterioration in the eurozone debt crisis could not have come at a worse time for the SNB. This could even give some investors an incentive to test the SNB, already.
It should also be noted that the underlying balance of CHF flows, from the current account and funding unwinds perspective, is still supportive for the Swiss franc. It is not really clear whether the introduction of a ceiling, i) will temper the unwinding of Swiss funding trades or whether ii) it will actually exacerbate this unwind as we now have better levels to liquidate liabilities. While the initial impact is clearly Swiss negative, the longer-term implications are more difficult to assess.
At the end of Q2, in our latest quarterly FX publication, we had a year-end target at 0.80 and 1.1760 respectively for USD/CHF and EUR/CHF. It now looks like we will have to adjust to a more bearish bias on the Swiss franc, but not significantly so (for EUR/CHF in particular). Meanwhile, the potential long-term inflation risks resulting from the new SNB’s strategy imply that the Swiss curve should steepen going forward.
From a macro perspective, this is all reassuring for Swiss exporters who have been affected by both the external value and volatility of the Swiss franc in the past 18 months.
However, remember that even at 1.20, the Swiss franc is still roughly 20% overvalued, so exporters will be hoping for more should the SNB manage to sustainably keep EUR/CHF above 1.20. Further adjustments in the SNB’s ceiling level are plausible in the future.
Audrey Childe-Freeman is Global head of Currency Strategy, and Cesar Perez is EMEA chief Investment Strategist at JP Morgan Private Bank.
