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Ideas & Debate

Currency intervention in crisis that’s as sharp as a Swiss knife

People queue to change their Swiss francs at a
People queue to change their Swiss francs at a currency exchange office in Geneva. PHOTO | AFP 

They say as sharp as a razor, but have you met the Swiss? The Swiss are known as purveyors of distinct chocolates, true connoisseurs of the fine art of watch-making, among other accomplishments.

But how often does one come across the phrase as sharp as a Swiss army knife? In this case, in the markets, we are referring to the Swiss National Bank (SNB), which is as sharp as a tack for its spot-on currency intervention moves.

Earlier in January, the Swiss franc hit its strongest level against the euro in almost three years after the United States added Switzerland to its watchlist of currency manipulators.

The euro dropped nearly 0.5 percent to 1.0760 francs (EURCHF), leaving the Swiss currency at its strongest since April 2017. Currently the cross is trading at 1.0785, 25 pips higher from that January level.

The line in the sand for the SNB is 1.0500, this level was touched twice in April and May but there was no follow through lower, clearly indicating that there was a lot of protection and interest watching the market at that level.

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Trading the Swiss franc against its crosses is akin to scratching poison ivy, it really feels good for a second but later it is highly regrettable due to the covert currency intervention which would often result in traders losing money in currency positions.

The SNB has bought huge amounts of foreign currencies in recent years to dampen demand for the franc, whose general safe-haven status attracts investors’ flows during times of uncertainty such as experienced during these Covid-19 times hence driving the franc strength. As well as intervening directly, the SNB has also imposed the world’s lowest interest rates to deter investors at minus 0.75 percent.

The Swiss franc tends to appreciate in value against its currency peers, more so because the country runs a gigantic current account surplus. The SNB stated that Switzerland widened its current account surplus by $29 billion to $87 billion dollars in 2019.

The SNB denied its interventions to weaken the currency were intended to give Switzerland a trading advantage, citing the negative effects on inflation and its export-dependent economy from a too highly valued franc.

Switzerland runs a bilateral trade surplus with the US. Notably, Japan too is on the currency manipulation watchlist, but no one does it more adeptly and with such panache as the Swiss.

Our view at Mansa-X is that the Swiss franc’s strength could gather momentum on a renewed rise in risk aversion brought about by Covid-19 slowing economic progression further despite the central bank’s efforts to contain the currency’s appreciation.

A rise in sight deposits — the central bank’s holdings of overnight funds for commercial banks-illustrates that the Swiss National Bank is intervening "regularly and often" to keep EURCHF above 1.05, the line in the sand.

However, we think EURCHF could fall below 1.05 on weak data that fuels global recessionary fears and boost safe haven demand for the franc, especially if the economic bounce expected from the reopening of the Eurozone economies fails to gather steam.

Although we acknowledge that a fall is unlikely to happen in one drastic swoop as was the case in 2015, it is likely to happen slowly and moderately due to the SNB’s continued interventions in the foreign exchange market to prevent the franc from appreciating too much on safe-haven demand.

But to what end? The Swiss franc’s persistent strength is the central bank’s own making. The market will not easily forget the fact that the Swiss National Bank stopped intervening in 2015 and abolished the minimum exchange rate and now, the SNB has been paying for it.

The Swiss National Bank’s practice of currency interventions has created a predicament for the central bank itself. The lesson to be learned from the experience of the last two months is that a supposedly flexible intervention strategy can easily get stuck. Foreign exchange intervention only works if credibly defended.

Also what has been witnessed in the market these last two months is that speculative investors have reduced bets for a stronger Swiss franc as it is becoming clear the central bank is willing to curb the currency’s appreciation.

The Swiss National Bank seems to be holding the line in EURCHF at 1.05 pretty successfully. Market investors appear to have got the message and are giving up fighting the SNB. Joining the fray is the People’s Bank of China (PBOC), which fixed the Chinese yuan (CNY) at a 12-year low against the US dollar in late May.

This move suggests there is less interest for the central bank in defending the stability of its currency at this time, which previously, market investors drew the line in the sand for the USDCNH at 7.0.

Yuan depreciation pressures have been building, attributable to China’s failure to deliver upside surprises in its stimulus plan unveiled at the National People’s Congress and Beijing's passing of a national security law for Hong Kong.

My view is that rising US-China tensions point to a weaker Chinese yuan against the dollar. We have traded this asset pair before and we will be looking to go long as the tensions could push USDCNH above 7.15.

Several developments that are ramping up tensions, including the US Senate’s approval of a bill that would require Chinese companies to be delisted from US stock exchanges if they do not meet US accounting standards, as well as China passing national security laws for Hong Kong.

Foreign exchange markets have begun to price in higher risk, notably with USDCNH trading above 7.12. Whatever your take is, this would be a good trading horse for June, or get a Swiss army knife.

Janot is senior dealer, Mansa X Fund (a product of Standard Investment Bank).

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