View: FX floor to remain unchanged for now, USD/CHF still the better bet
No matter what the excuses, and in this case they look poor, it’s impossible to think that any central bank chief could survive one’s wife booking healthy profits on FX trades made ahead of key policy decisions. And so exits CNB President Philipp Hildebrand, which is a shame as he was one of the more interesting of his type. His brief tenure (barely 2-years in the top spot) had been marred by controversy, having survived earlier criticism after his failed efforts in 2010 to curb CHF appreciation – after exhausting more traditional monetary policy options – led to record losses at the bank…………..
Full report attached:
View: SNB’s currency floor creates a carry neutral EUR/USD proxy, widens options for many others
The Japanese may have fired off the first salvo, persuading the balance of the G7 to support intervention to weaken the JPY following the Tōhoku earthquake back in March but it has been left to the Swiss to act with any real aggression in the so called ‘Currency Wars’ with a landmark step this morning, enacting a floor in EUR/CHF at 1.20 and offering unlimited amounts of CHF to defend this marker. The statement also pledged a readiness to adopt further measures should economic and deflationary risks warrant. Brave stuff.
Pressure had been building on the Swiss for some time. Clearly the franc is massively overvalued in both nominal and real terms and earlier – more orthodox – steps have proved ineffective. The minimum exchange rate option then is probably the only viable method of restraining the currency over the medium-term. There will of course be speculation about the resolve of authorities to defend this statement; Hildebrand came close to being forced out after earlier measures led the SNB to a US$21bn loss. But this policy is far more aggressive and the stakes immeasurably higher. More probable is that alternate safe havens should see a chunk of the otherwise Swiss destined flow (including gold and the high yielders).
Of course geography means targeting a rate vs. the EUR is the logical choice, though it also might reflect SNB expectations that the EUR itself is too rich – the statement noted that the SNB was aiming for a substantial and sustained weakening of the Swiss franc. Pegging oneself to a currency that ought to be cheaper could mean a return to more normalised levels of exchange is quicker that first appreciated. That said the BIS suggest the CHF is 34% overvalued in NEER terms so normal still might not mean fair.
At this point we have reasonable confidence that the SNB policy will take some of the heat out of the CHF, even if this leaves the pair range trading above EUR/CHF1.20. In some respects it could even find itself a beneficiary of the carry trade, CHF being cheaper to short than EUR. It would be ironic if USD/CHF now became the route by which the market expresses its bearish EUR/USD ideas. Looking at the USD/CHF chart a 0.9401/45 target does not look unreasonable with this in mind.
Examining SNB resolve in the broader global context is equally interesting. We’ve already seen those free floating emerging currencies vex over hot money inflows, most vocally Brazil but also places like South Africa where the macro story is hardly compelling enough to warrant the level of exchange rate gains the country has seen. A peg or quasi peg might look alluring to such players.
Equally this type of policy might be right for the Japanese – even if the yen is nowhere near as overvalued as the likes of CHF, BRL or the antipodean currencies. More relevant for the Japanese is the policies of its direct competitors, most of which operate some form of dollar peg. As we’ve noted before one only has to look at the market share grabbed by Korean corporates to realise the scale of the problem. Taking the moral high ground gets you nowhere in such instances. Free floating currencies are only viable in a world of freely floating currencies. A JPY currency floor would certainly focus minds on this type of anti-competitive behaviour, particularly at a time when the Fed and other central banks (UK specifically) are perceived to be mulling more quantitative easing (or similar) with the repercussions this ought to have for the dollar and its associates (CNY, KRW etc). PM Noda take note.
- SNB euroquake, the analysts react – part two (ftalphaville.ft.com)
- Two Opposing Views On The SNB Intervention, Or Rather One View (Goldman’s) And One Cartoon (zerohedge.com)
Liquidity pressures have forced the ECB to step into the market again, the bank announcing new six-month measures to try and ease money market tensions at this afternoon’s rate setting meeting (rates were held at 1.50%) in addition to the no doubt more distasteful step of returning to support peripheral bond markets – Portgual and Ireland benefitting in the first instance. Trichet claimed the bank had not previously ceased its purchase programme – stating he had never personally said it was dormant, but this just look like semantics to us. The bank has never been comfortable with this course of action and the fact that the ECB is back in the market (and not with unanimous support from the council) speaks volumes about the scale of the crisis enveloping the region and the steps needed to provide even a small perception of control.
The timing of today’s meeting is a little unfortunate given the moves from the Swiss National Bank, Bank of Japan and Central Bank of Turkey this week. While action during the first financial crisis was very much a global affair, what stands out now is the unilateral nature of these steps, The Turks noting the action was designed to protect against the risk from peripheral Europe and a US slowdown despite currently solid local macro fundamentals and already competitive exchange rate (earlier monetary policy moves having weighed heavily on the TRY). This is not that surprising, sovereign balance sheets have been trashed over the past three years, significantly weakening the hands of governments desperate to stimulate growth. Deleveraging, which was the only real solution, will never fit into the electoral cycle. The imbalances that contributed to the crisis are also still very much present, indeed in many instances exaggerated. One just has to look at Germany and the level of Asia FX reserves to see how the much criticised export driven model has survived.
There is a real risk now that these unilateral steps are repeated elsewhere as authorities look to build protection against the feared slowdown in global growth. Many indicators are already alluding to this, for example JP Morgan’s global PMI index (above) is now only marginally above the 50.0 level and Citi’s global economic surprises index (below) has been printing negative surprises ever since the Japanese earthquake, a sign the market is behind the curve. If one throws the probability of the odd sovereign default into the mix (peripheral Europe), the probability of a US downgrade and prospects for further tightening in China the temptation to try and get that first mover advantage can only increase.
It’s difficult to envisage a scenario where there is a clean resolution to current problems. If the Fed embarks on new policy stimulus it will likely be dollar negative, exaggerating tensions between the free floaters and the pegged currencies. Hopes of faster Chinese appreciation which might allow more flexibility across Asia doesn’t fit well with slowing global growth either. A round of competitive devaluations and a plethora of new tensions (i.e more obvious protectionism) looks like a logical next step, a multilateral solution will be near impossible to forge if this begins, if it’s not already. One only has to look at the European situation to understand how difficult it is to find a consensus and the debt ceiling clash in the US is even more glaring.
We’ll dare to name a few potential – if not that radical – flash points: Japan/Korea, BRL heading an EM block vs. the dollar and the classic CNY vs. USD, something US politicians might actually be able to unite on.
- ECB acts to ease euro zone tensions (theglobeandmail.com)
- Yen Plunges as Japan Intervenes in Market First Time Since March (businessweek.com)
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