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After a brief flirtation with “normalization” global central banks are now decidedly dovish. Likely to re-embark on a global easing cycle, starting with FOMC July 31st meeting. While the Fed has been the most public reversal in policy stance the ECB & BoJ has also turned more dovish, as the inflation outlook remains weak and growth slows. Market expectations for the ECB to follow the Fed in September with interest rate cuts and additional asset purchases. While market consensus is for ECB action in the autumn, there is a likelihood of a -10bp cut on Thursday. The market seems comfortable with this idea since Euro-dollar two-week implied volatility is below the past-year average, even after ECB meeting indicated that policymakers ready to disclose economic stimulus. ECB could surprise markets by the magnitude or the timing of its potential easing measures but it’s widely held that actions are coming.
This will likely drive the SNB, to become more dovish.
January 15th, 2015 the SNB suddenly declared that it would no longer maintain the minimum Swiss franc at a fixed exchange rate with the euro. This move was preemptive to avoid the expected CHF inflows from an ECB going negative.
While the macro environment is nowhere as sever today, conditions are similar. We have good visibility that the ECB will ease further, sparking a rotation of capital into Switzerland. Action becomes a bit blurry after that. The high probably play is that the SNB will take official interest rates more negative.
Following much-publicized comments, SNB President Jordon's view that interest rates can go deeper into negative territory. In the past, Jordon stated, “If we come to the conclusion that it’s necessary to fulfill our mandate, then, of course, we’re ready to use our monetary policy instruments.”
Although the SNB is communicating a frictionless environment to policy setting we suspect things are more complicated. The central bank’s massive balance sheet has become a concern and assuming more FX exposure (even converting into equities) is not a given. Remarkable failure of the SNB to intervene in any material size during the Italian crisis last year indicates that the SNB's capacity to intervene is inhibited. In addition the reality, the US Treasury labels Switzerland a "currency manipulator" is real. US president Donald Trump has not backed down on using FX as a policy tool, accusing China and Europe of maintaining their currencies “unfairly” weak. The US Treasury removed Switzerland from its currency manipulator watch list in May, significant trade surplus with the US keeps the Alpine nation a clear target. While negative interest rates are hurting, banks and savers while providing upward momentum to housing prices (highlighted in the statement & stressed by UBS in 2Q earning report).
At the start of the 2007-2008 financial crisis SNB reserves stood at a mild 15% of GDP. But after extreme easing cycle that including multiple direct FX intervention, negative interest rates FX and setting a hard minimal exchange rate against the Euro, reserves are at an unstable 120% of GDP. This suggest the SNB will accept more CHF appreciation.
With global monetary policy normalization reversing, and macro-economic risk increasing, CHF will remain in high demand. Historically, CHF has outpaced G10 FX during Fed easing cycle and recession. Despite the SNBs negative interest rate policy and threats physically intervene in currency markets, CHF is the king of economic safe-haven plays. Switzerland has the largest current account surplus as a percent of GDP in the majors. Swiss account surplus is 10% of GDP, significantly higher than JPY, the other pre-eminent FX safe-haven. This fact gives CHF a reputation of a credible recession, anti-cyclical hedge.
The stickiness of capital in Switzerland has been a real problem for the SNB. It’s unlikely that with the global economy decelerating the key central banks poised to ease that the private sector will begin export capital. With EURCHF at critical support of 1.1000 how and when the SNB will act is on everyone’s mind. Clearly, SNB member should get some rest because summer is looking to be eventful.