13 března 2009

13/3 Swiss Franc after yesterday's actions

The Swiss National Bank was out yesterday declaring all out war on the strengthening Swiss Franc, announcing strong new expansive monetary policy measures and getting right down to business with direct intervention in the currency market. The central bank timed the announcement and intervention with an already expected cut to its 3-month Libor target to 0.25% from 0.50%.

Lately, the Swiss Franc's strength was closely tracking equity weakness inversely, meaning the franc rallied as the mood soured in equities. The SNB had periodically tried to shoot across the market's bow with verbal intervention in the recent past, but traders seemed to be a bit complacent judging from yesterday's very sharp response to the SNB announcements.

The sharp equity rally of recent days coupled with this dramatic new policy response form the SNB sent EURCHF on a rocket ride toward key resistance in the 1.5300/1.5400 area - more than 5% up from recent lows and the sharpest move higher since the Euro's introduction. The move by the SNB to intervene was accompanied with announcements of new, so-called quantitative easing measures designed to avert the risk of deflation with the purchase of Swiss corporate debt.

The SNB has good reason to step in here: the country's heavy dependency on exports makes a strengthening currency particularly dangerous and deflationary as surplus nations are now bearing the brunt of the fallout from the global contraction in trade and consumption.

This has been mostly painfully evident in the Japanese experience. Second, Switzerland has enormous exposures to Eastern Europe, particularly in the form of mortgages, as more homebuyers financed in low yielding CHF loans rather than in their local currency during the boom times.
Any purposeful weakening of the franc, therefore, is a de facto bailout effort aimed toward Eastern Europe as it helps to ease some of the self-reinforcing process of capital flow pressures on the region. This latter reason allows the SNB to "get away with" weakening its currency to a certain extent without invoking hostility from other nations.
Looking ahead, we suspect that the SNB is not targeting any particular level in EURCHF, though 1.5000 is a likely line in the sand for support, both psychologically for market participants and for the SNB. To the upside, the next big level beyond the highs today at 1.5400 are 1.5850 and then 1.6000. In general, if the equity rally turns into a larger rally that extends beyond perhaps 800 in the S&P500, we could certainly see a test of the 1.6000 level, whereas if equities turn tail once again, the EURCHF cross is likely to simply stumble randomly in a range as the market is unwilling to fight a determined SNB and unwilling to sell francs due to the old pressures on CHF appreciation still very much in evidence.

The next key test for the CHF crosses could come at the April 2 G20 meeting, which could show larger efforts aimed at bailing out the struggling CEE economies. More broadly speaking, this announcement sees the SNB joining the US Fed and the BOE in competitive devaluation efforts: no nation wants an overly strong currency in this global economic environment - and the competitive devaluation theme becomes a dominant one.

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