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Article / 17 June 2016 at 2:55 GMT

Swiss franc likely to become Brexit's collateral damage

Managing Director / Technical Research Limited
New Zealand
  • The SNB said Brexit may cause uncertainty and turbulence to increase 
  •  But the fallout could match that of when the EURCHF peg was abandoned
  • The Swiss franc may become collateral damage following Brexit 
  • A cut to the deposit rate, perhaps to minus 1.00%, is needed sooner rather than later 

By Max McKegg

Ahead of next week’s Brexit vote, safe-haven flows are moving into the Swiss franc, adding to upward pressure caused by declining bond yields worldwide and a US Federal Reserve retreating to the sidelines. Yesterday’s quarterly monetary policy assessment from the Swiss National Bank acknowledged the risks around the situation, especially as the exchange rate is already “significantly overvalued” and needs to decline if the Bank is to have any hope of meeting its 2% inflation objective. 

Tough situation ... safe-haven flows are moving into the Swiss franc ahead of Brexit
putting upward pressure on it. Photo: iStock

As shown in the chart below, the SNB’s inflation forecast for the next year has risen compared with that given in its March policy statement “principally due to the increase in oil prices in the intervening period”. However, according to the Bank’s model, this effect “vanishes” mid next year and the inflation track for 2018-19 reverts to its previously estimated path. The Bank says the medium-term outlook is consistent with inflation expectations surveys. 

The three-year ahead forecasts assume Swiss Libor remains at minus 0.75% during the entire period.
 Source: Swiss National Bank

Consistent with previous statements, President Thomas Jordan emphasised that the SNB’s monetary policy is based on two key elements: negative interest rates ( “an absolutely essential instrument at this point in time”) and a willingness to intervene in the foreign exchange market. 

The Bank’s determination to reduce the attractiveness of Swiss franc investments – both to domestic and offshore investors – is illustrated in this chart of the Confederation bond yield curve. Today the 30-year dipped into negative territory, giving Switzerland the dubious honour of negative rate champions. 

This situation is unlikely to change in the foreseeable future: the target range for 3 month Libor is being maintained at minus 0.25% to minus 1.25%. As of now it’s sitting right in the middle.


Source: Bloomberg

On the currency front, the SNB will be chagrined that Brexit-induced safe-haven flows are threatening to undo the positive developments since the 1.20 EURCHF peg was abandoned in January 2015. 

As this chart shows (click to enlarge), the effective exchange rate, also known as the trade-weighted-index, had been drifting down until recently. But with German bund yields still falling, a US Federal Reserve backing away from rate hikes and the UK threatening to leave the European Union, Swiss franc deposits have become more attractive on a relative basis.
Source: Bank for International Settlements, Metastock

What can the SNB do about it ? Firstly, it can keep its fingers crossed the Brits won’t score a massive own goal by voting “Leave” next week. But even if sense prevails, developments in other financial markets will keep upward pressure on Switzerland’s exchange rate. 

Yesterday the 10-year government bond yield in AAA-rated Australia dropped under 2%, dragged down by global forces. So far the Swiss yield curve has moved in sympathy and, incredibly, 50-year Confederation bonds may soon offer a negative return. But to keep ahead of the pack the SNB will soon have to start manoeuvring its Libor rate closer to bottom of its minus 0.25% to minus 1.25% target range.

The alternative is to up the ante on FX intervention. But, as this chart shows, sales of CHF in exchange for foreign currencies are already on a steep trajectory; indeed to such an extent that the SNB's balance sheet is now almost the same size as the entire Swiss economy.

Source: ABN Amro

The SNB’s monetary policy assessment said Brexit “may cause uncertainty and turbulence to increase” in already fragile financial markets. That may be an understatement: the fallout could, in fact, match that of January 2015 when the EURCHF peg was abandoned. 

But with interest rates already the lowest in the world and a balance sheet bloated by previous FX interventions, the SNB is not in a position to offer much resistance to the Swiss franc becoming collateral damage. And given the global situation, even a “Stay” vote in the UK next week will not take the pressure off the SNB for long. 

A cut to the deposit rate, perhaps to minus 1.00%, is needed sooner rather than later or the Swiss franc’s recent rally will accelerate.

– Edited by Gayle Bryant

Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade or article then click here or post your comment below to engage with Saxo Bank's social trading platform.
17 June
Patto Patto
good analysis of the situation....
17 June
Max McKegg Max McKegg


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