In the third quarter of 2007, the Swiss franc rallied sharply against the U.S. dollar on evidence that problems in the U.S. subprime market and the liquidity shortage in the money markets were creating serious problems for the world’s largest economy.
From the middle of June to the end of September, the US dollar lost nearly 6.7 percent against the Swiss franc, trading from a high of 1.2468 reached on June 14th to a low of 1.1628 on September 28th. The recent nervousness on the financial markets has prompted many investors to close out carry trades but the impressive strength of the Swiss franc against the U.S. dollar did not extend to other G-10 currencies. The Swissie has been underperforming particularly against higher yielding currencies like the Euro, Australian dollar and Canadian dollar. Since the beginning of 2007, the Swiss franc lost 3.18 percent against the Euro, 8.34 percent against the Australian dollar and nearly 12.6 percent against the Canadian dollar.
[B]Switzerland’s economic growth remained robust despite the recent turbulence in financial markets[/B]
The turmoil on the U.S. credit markets seems to have had a limited impact on the Swiss economy. In its quarterly monetary policy report, the Swiss National Bank admitted that cyclical risks have increased as a result of the recent financial market instability but the monetary authorities also noted that economic growth in Switzerland remained robust during both July and August and confirmed their forecast for a GDP growth of 2.5 percent for 2007. In August, many financial institutions were confronted with a lack of liquidity but the Swiss National Bank reacted quickly by injecting overnight liquidity into the financial system. On August 9 and 10, in a move to restore calm to the Swiss money market, the SNB injected 3.14 billion in overnight liquidity. In the same two days, the European Central bank added a total of a total of 156 billion euros to the system and both the US Federal Reserve and the Bank of Japan all temporarily injected money into the banking system. Yet, even though the turbulence in the international financial markets in August caused concern within the Swiss banking sector, economic prospects continued to be viewed as positive. Talks held by the SNB delegates for regional economic relations with around 150 representatives from various economic sectors and industries held between June and August suggest that the Swiss economy grew rapidly across all sectors during the summer months. In fact, the banking industry was again the most significant driver of GDP growth, contributing nearly one percentage point to the overall number. Moreover, the SNB is not the only one optimistic about the prospects of future economic growth. Recently, Switzerland’s State Secretariat for Economic Affairs revised higher its 2007 GDP growth forecast to 2.6 percent from a 2.3 percent forecast in June.
[B]The Swiss economy is likely to continue to grow but at a slower pace[/B]
During the last quarter, external demand, strong consumer spending and a large increase in equipment investment accounted for the biggest share of the GDP expansion. Spending among consumers has been boosted by the current situation of the Swiss labor market which continued to improve in the third quarter of 2007. According to the SNB, the number of people registered as unemployed decreased to 105,900 between May and August, which corresponds to a drop in the unemployment rate from 2.8% to 2.7% and the seasonally adjusted rate of unemployed persons is expected to decline further to approximately 2.5% by the end of 2007. The largest proportion of additional jobs was created in the service sector but employment growth was broad-based across all sectors and the overall unemployment rate is now close to its lowest levels since October 2002. However, although the Swiss economy is forecast to grow in 2008, it is expected to do so at a much slower pace. According to the University of Zurich’s Centre for Economic Research KOF survey, a monthly aggregate of indicators that aims to predict the direction of the Swiss economy six months forward, the current growth rate will contract gradually by the end of the year as a result of weaker exports that is possibly hurt by a slowdown in the economies of Switzerland’s biggest trading partners. Also, higher interest rates are already having a dampening effect on the construction industry. In the second quarter of 2007, construction investment fell by almost 14 percent and was the only component of the GDP to decrease.
[B]The recent appreciation of EUR/CHF is helping the Swiss economy. The question is, for how long?[/B]
The Swiss economy continues to benefit from the largest period of prosperity in the global economy and the external demand for Swiss products has been particularly boosted by the favorable exchange rate of the Swiss franc against the Euro. In the last nine months, the Swiss franc lost nearly 3.6 percent against the Euro, trading from a January low of 1.6096 to an all time high of 1.6686 reached last July. According to the latest SNB statistics on external trade, around 60 percent of Swiss exports go to the Euro area, 15 percent to the United States and only 10 percent of Swiss exports go to various Asian countries. On one hand, a weak franc makes Swiss goods more competitive abroad but on the other it also increases the risk of importing inflation since the Swiss economy becomes more vulnerable to a surge in international energy and commodity prices. However, looking ahead and assuming most of the Swiss goods are purchased using Swiss francs, the currently low level of the franc against the Euro is not sustainable. We believe the higher level of demand for francs should place upward pressure on the value of the Swiss currency and such inflows may lead to a depreciation of Euro in the months ahead. Moreover, even though the ECB has been clearly more hawkish than the SNB over the last year, the current circumstances could be about to change. While the European central bank is becoming more neutral in the face of the rapid appreciation in the Euro and some early signs of deterioration in the Euro area economy, the Swiss National Bank is still confident in their economy and focused on inflation. Recently, Jean-Pierre Roth, the Swiss National Bank president, said the current subprime market crisis in the US is unlikely to have a significant effect on the Swiss economy and even though he expects the Swiss economy to “slow down somewhat in the second half of the year” current data shows “a rather positive picture”.
At its monetary policy assessment of September, the Swiss National Bank raised the target range for the three-month Libor by 0.25 percentage points from 2.50 percent to 2.75 percent. Yet, despite the rate hike this was not a hawkish statement as the latest developments in the international financial markets associated with the US mortgage crisis made the SNB assessment of the Swiss economy and inflation pressures less certain. Aiming to calm the Swiss money market (the three month Libor rate rose as high as 2.9% due to particularly high credit risk premiums), the bank acknowledged that due to the international credit crisis the downside risks for the Swiss economy are somewhat stronger, but despite the recent turbulence of financial markets, economic growth in Switzerland continues to meet expectations. More importantly, SNB monetary policy officials said they remain worried that higher oil costs will translate into higher production costs and decided not to change their inflation outlook. Assuming, the three-month Libor rate remains steady at 2.75% over the next three years, the central bank still expects an average annual inflation rate of 0.6% in 2007, 1.5% in 2008, and 1.8% in 2009. The Swiss National Bank is closely monitoring the consumer price index and any positive development in the current financial markets condition could prompt the SNB to raise rates one more time. If this hawkish scenario becomes reality, higher interest rates will probably make holding the Swiss franc more attractive to foreign investors and the higher cost of holding loans based on Switzerland should make the Swiss franc less attractive as a funding currency against higher yielding currencies. In this case, we would expect the Swiss franc to appreciate the most against the U.S. dollar and for a less extent against the Euro. On the other hand, a larger than expected slowdown in the world economy, triggered by an acceleration of problems in the credit market could make the Swiss franc particularly vulnerable against the Japanese yen as the world flees from carry once again.
[B]USDCHF Technical Outlook[/B]
Last quarter, we wrote that “a triangle is unfolding from the May 2006 low at 1.1920. In this instance, a thrust below 1.1877 would occur soon and test the 78.6% of 1.1286-1.3285 at 1.1714 and likely lower levels. This is now the favored count and is shown on the chart.” The USDCHF broke lower and traded to 1.1623 on the first day of October. Expect a drop below 1.1623 to complete the terminal thrust from the triangle. A rally should then unfold and bring price back to at least the center of the triangle near 1.2200 although bullish longer term bullish potential is much greater.
[B]Written by DailyFX Research Team[/B]