[B]The Swiss Franc Rallied Against the U.S. dollar in 2007, but Will it Continue to Appreciate in 2008?[/B]
In the last quarter of 2007, the Swiss franc staged an impressive rally against the U.S. dollar on evidence that the interest rate differential between Switzerland and the United States was becoming too small to compensate investors for assuming risks on the increasingly volatile U.S. financial markets. More specifically, from October 1st to the middle of December, the U.S. dollar fell nearly three percent against the Swiss franc, trading from a high of 1.1894 reached on October 9th to a low of 1.0885 on November 23rd. In fact, while the Swiss National Bank remained concerned that inflation could accelerate after the economy expanded at the fastest pace in the last decade; the U.S. Federal Reserve was forced to cut its benchmark interest rate by 100 bps to 4.25 percent to prevent the U.S. economy from sliding into recession. Furthermore, problems in the world credit markets, triggered by a wave of payment defaults in the U.S. subprime sector, forcing many investors to cut holdings of the carry trade. This hyper volatility brought by the collapse in the U.S. subprime market helped the Swiss franc gain 3.94 percent against the Australian dollar, 3.03 percent against the British pound and nearly 5 percent against the Canadian dollar in just ten weeks.
[B]Switzerland is Headed for its Fourth Straight Year of Above Trend Growth [/B]
Despite the recent turmoil in the world’s financial markets, which is threatening to end the longest streak of global economic growth, Switzerland seems headed for its fourth straight year of above trend growth, boosted by strong exports, consumer spending and strong investment in equipment and workers’ productivity. According to the Swiss National Bank, the Swiss economy remains in a “very good shape”, domestic demand is robust and growth in employment has been broad based. Moreover, Switzerland’s central bank projected growth in real gross domestic product at more than 2.5 percent for 2007 and expected Swiss GDP growth to settle at around 2 percent in 2008. However, although the Swiss economy has been relatively immune to the turmoil in global capital markets, the slowdown in global growth crated a degree of caution in the country’s monetary policy. In fact, for the first time in two years, the SNB decided to leave the target range for the three-month Libor rate unchanged at 2.25–3.25%, arguing that the expected slowdown of the global economy was likely to result in an improved inflation outlook for 2008 and 2009. Assuming that the three-month Libor remains unchanged at 2.75%, the SNB now expects an average annual inflation rate of 0.7% in 2007, 1.7% in 2008 and 1.5% in 2009. Back in September the SNB was more hawkish and expected an average annual inflation rate of 0.6% in 2007, 1.5% in 2008, and 1.8% in 2009. Yet, in our view, even though inflation prospects have become less certain due to the international credit crisis, risks for price stability remain on the upside. The low level of the Swiss franc against the euro, the continued high price of oil and the high degree of resource utilization are all important factors having an inflationary effect in the Swiss economy and are likely to pressure the SNB to increase the price of money during 2008.
[B]Is the Swiss franc Still a Safe Haven Currency?[/B]
At the beginning of August 2007, the U.S. subprime mortgage crisis spread like a shock wave across the world money markets demonstrating the tight integration of international financial markets. Yet, although the extent of damage done by the wave of payment defaults in the subprime sector of the U.S. economy has never been anticipated by the SNB, the Swiss central bank reacted rapidly to the tensions in the Swiss franc money market and was one of the first central bank to provide additional liquidity on August 9, 2007. But is the Swiss franc still a safe haven currency? Yes and no. Although Switzerland continues to retain its status as the safe haven destination for the world’s capital in times of geopolitical stress, the country’s currency is no longer highly correlated with other safe haven assets. At one time, the currency was 40 percent backed by precious metals, but in 2005 the Swiss government sold the nation’s vast inventory of gold. As a result, the franc did not benefit from gold’s spectacular rise above the $855 level traded in November 2007. However, the recent increase in market participants’ perception of risk is fueling a flight to safety that in turn could lead to an abrupt unwinding of carry trades boosting safe haven and lower yielding currencies like the Swiss franc and the Japanese yen.
[B]
EUR/CHF Becoming Overvalued[/B]
Over the last five years, the Swiss economy has been benefiting from a favorable exchange rate with the Euro area. In fact, from January 2002 to December 2007, the Swiss franc lost nearly 17 percent against the euro, trading from a low of 1.4437 reached on July 2002 to a high of 1.6826 this October. Looking back, such a sharp appreciation of the euro against the franc can be easily attributed to the divergence between the monetary policies of both regions since the European Central Bank has been clearly more hawkish than the SNB on its interest rate hikes. However, as the slowdown in the euro area economy becomes more evident, the ECB is becoming less supportive of a strong euro, this could be a new state of affairs that will force many Swiss companies to look beyond exchange rates to make Swiss goods more competitive abroad. According to the latest SNB statistics on external trade, 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. In addition, the Swiss National Bank is also not interested in having a weak currency since the Swiss economy becomes more vulnerable to a surge in international energy and commodity prices.
[B]Key Points[/B]
Understanding the Swiss National Bank monetary policy is a crucial step if one wants to anticipate how the Swiss franc will perform in 2008. While the SNB conducts the country’s monetary policy as an independent central bank and its primary goal is to ensure price stability, the central bank also needs to promote the best environment for economic growth. In our view, despite the recent turmoil in the world financial system, the SNB is likely to continue normalizing its key interest rate in order to guarantee price stability. According to interest rate futures for deposits denominated in Swiss francs, traders are clearly pricing two more rate hikes in 2008. While the overnight interest rate pays 2.6 percent, the 3 month rate pays 2.78 percent, the 1 year Libor rate 2.96 percent and the 10 year note pays more than 3.32 percent. If those rate hikes do happen, the additional monetary tightening should provide further support to the Swiss franc and make the Swiss currency less attractive as a funding currency for carry trades. Furthermore, confidence among financial market participants in the global financial system remains scarce and this could have a positive effect in the market valuation of the Swiss franc. In fact, assuming risk aversion will continue to be the predominant theme across financial markets in 2008, investor’s appetite for high yield and high risk assets is not likely to return, a market environment that could favor a further unwind of carry trades and benefit lower yielding currencies like the Swiss franc. Looking ahead, we target the USD/CHF at 1.1000 in three months and we expect the Swiss franc to reach parity with the U.S. dollar before the end of 2008.
[B]USD/CHF Technical Outlook: New Low Expected Before Any Significant Rise[/B] – [I]By Jamie Saettele[/I]
Last quarter, we wrote to [I]“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.”[/I] We were obviously off on the USDCHF call as the pair fell to multi decade lows (1.0886) before staging a rally back to 1.1594. The count is similar to the EURUSD (inverse of course though). The recent rally (1.1594) completed wave 4 within the decline from 1.2468. As such, a new low is expected in wave 5 (below 1.0886) before we can expect any kind of significant rally. An objective is 1.0616 (61.8% extension of wave 1 through 3).
