[B]Will the Swiss Franc Stumble, If The SNB Falls Behind The Curve?[/B]
The slowdown in the U.S. and a weakening European economy are beginning to weigh considerably on Swiss growth. Furthermore, inflation concerns continue to mount as energy and raw material costs reached record highs during the past quarter. Yet, despite the upward pressure of rising prices, the SNB has decided to leave their benchmark rate unchanged for the third quarter in a row, at a time when other central banks are expected to tighten monetary policy. Considering the fact that the Swiss monetary authorities only meet once every three months, the SNB may find itself behind the curve, and the low yielding currency could see its interest rate differential erode against other major currencies. Nevertheless, investors’ attitude toward risk may ultimately have the most influence on the currency much as it did during the past quarter with risk appetite ultimately giving way to risk aversion.
[B]Which Way Will Risk Winds Blow?[/B]
The Swiss Franc has lost some of its status as a safe haven currency, but risk continues to be the main driver of the currency. The USDCHF started the quarter with a 90 bps jump as Lehman brothers was able to raise $4 billion dollars in convertible preferred stock. The investment bank’s ability to raise capital gave investors hope that the credit markets were improving as central banks supplied the necessary liquidity. However, risk appetite returned when Fed bailed out Bear Stearns and opened the discount window to investment banks. As a result USDCHF would ultimately rally 700 bps from its March 17th low, before peaking on May 8th at 1.0623. The prior quarter saw the Franc trade above the dollar for the first time ever. However, a near 700 point gain in the Dow mid April would send the safe haven currency below the dollar for the remainder of the quarter. Despite the fall, the Franc remains 15% higher than a year ago, as the country’s economy remained resilient and lingering effects from the subprime crisis has tempered risk appetite leading the pair to consolidate in the 1.0150-1.0550 range
[B]Inflation Saps Consumer Spending Despite Strong Labor Market[/B]
The Swiss labor market has remained strong in the face of a slowing economy as the jobless rate has held at the lowest level in almost five years at 2.5%. In fact the latest SVME purchasing manger’s index actually showed an increase in the employment component as companies continue to hire. SNB officials have maintained that although they expect household consumption to moderate; it should remain relatively strong over the near-term around 1.9% before falling to 1.6% in 2009. The first two months of the quarter supported the central bank’s case as retail sales in February and March posted gains of 3.3% and 9.7% respectively, as rising wages fueled Swiss spending. However, April’s decline of 9.4% - the first in two years- shows that inflation has begun to erode consumer’s purchasing power. Indeed, the UBS consumption indicator has steadily declined through the period falling from 2.321 to 1.910. The gauge which is based on new car sales, retail sales and the number of overnight hotel stays by Swiss residents within the country is at its lowest level in 17 months. Consumers curbed spending as the growth outlook for the country dimmed reducing their purchases of leisure activities and clothing, which fell 24.5% and 24.7% respectively.
While spending slowed, prices accelerated at the fastest pace in 15 years in May at 2.9% on an annualized basis, rising 0.8% from April. The increase was the largest month to month gain since October 2007, led by rising energy costs. Indeed, heating oil prices rose 58% from a year ago, leading to a 6.0% increase in utilities. Still the majority of the price pressure emanated from outside the country as foreign goods prices rose 1.8% compared with 0.4% increase in domestic prices. The SNB and KOF have raised their inflation expectations for the year to 2.5% and 2.6% respectively, from previous estimates of below 2%. Inflation is expected to continue to weigh on consumers as the quarter saw oil prices reach as high as $140 per barrel. Meanwhile, the labor market is expected to weaken as banks hit by the subprime crisis continue to layoff workers and slowing exports may force manufacturers to do the same. Indeed, the SNB expects employment to fall to 0.5% by next March from 2.0% in June. Therefore, expect consumption to weaken, which may keep the SNB from raising rates in the medium term.
[B]Are Slowing Demand and Rising Costs Too Much For Swiss Manufacturers to Bear?[/B]
Inflation is becoming a serious problem for producers as well with input prices rising 3.9% from a year ago. Energy and raw material costs have begun to squeeze margins as costs for petroleum rose 9.2% and metal prices increased 2.5% in May. Since Switzerland fulfills the majority of its raw material needs through imports it will continue to be at the mercy of rising global commodity prices. At the same time growth has slowed, evidenced by the SVME purchasing manger’s index declining three of the last four months. The index in May fell to 55.7 after a rebound in April to 56.7, on declines in output, purchases and backlog of orders. For the time being Swiss producers have been able to differentiate their products making them less sensitive to the current downturn in the global economy. However, the slowdown in the U.S. and Europe has already taken its toll as Swiss exports declined for a second month. Overall, the Swiss economy is losing momentum as its current economic expansion slowed to the weakest pace in 3 1/2 years as GDP rose a mere 0.3% in the first quarter. This has led to the State’s Secretariat’s office lowering its growth forecast for 2008 through the first quarter of 2009 to 1.5% from 1.9%. As the European economy shows more signs of slowing and the U.S. has yet to reach a bottom, demand for Swiss goods should weaken throughout the remainder of the year.
[B]SNB Keeps Rates Unchanged As They See Inflation Transitory.[/B]
Given the slowdown in growth it is understandable why the Swiss National Bank left their benchmark interest rate unchanged at 2.75%. Prior to the meeting some market participants speculated that the SNB monetary policy committee would actually hike rates as inflation concerns mounted. Indeed, the statements following the release showed that the central bank increased their inflation expectations for the year from 2.0% to 2.7% as rising energy and food costs continue to filter throughout the economy. However, at present the SNB believes that inflationary pressures are temporary expecting price gauges to ease to 1.7% in 2009 and 1.3% in 2010.
[B]EURCHF Range Bound[/B]
The calming of fears pertaining to the financial crisis saw the EURCHF appreciate over 700 points in the quarter. The pair would consolidate in the 1.600-1.6380 range for most of the period, as rising inflation and slowing growth in the region held the pair in check. Although, the ECB is expected to raise rates at its next meeting while the SNB left rates on hold, the pair has failed to exceed its quarterly high of 1.6376 set on May 19th. The return of risk aversion and weaker equity prices have pulled the pair lower heading into the second half of the year.
[B]
SNB Holds to Key to the Swissie in Q3[/B]
The end of the second quarter saw a flight to safety as the lingering effects of the subprime crisis brought several major banks under the scope. The reemergence of risk aversion will increase the attractiveness of the safe haven Swiss Franc, as traders unwind riskier positions. However, the Swiss economy is also feeling the pain of the current financial crisis, as Swiss banks find themselves at the center of the storm. UBS recently removed four board members as the bank faces an investigation by the U.S. department of Justice concerning alleged U.S. tax evaders. Additionally, the continued downturn in the U.S. and the emerging slowdown in Europe will lead to a significant reduction in demand for Swiss goods and the continued weakening of the manufacturing sector. Oil reaching as high as $140 a barrel will continue to squeeze profit margins and weigh on domestic and global consumer demand. If inflation risks continue to mount, then the SNB’s failure to take preventive measures may prove detrimental for the Swiss economy. However, if the central bank is correct in its assessment that inflation is transitory then the Swiss economy may emerge as the strongest of the G10. Ultimately, risk sentiment will determine the direction of the USDCHF over the next quarter and as long as concerns remain regarding the financial crises the Franc will remain supported. However, the declining prospects for the economy, slowing domestic demand and the potential increase in interest rate differential may leave the pair range bound for the medium term especially if global economic growth slows but does not collapse altogether
[B][U]USD/CHF Technical Outlook[/U][/B]
[I]
By Jamie Saettele[/I]
A new low (below .9647) is expected in the USDCHF. Similar to the EURUSD (but in the inverse), the rally from .9647 was in just 3 waves (see inset). Since we know that 3 wave movements are countertrend, we know that the USDCHF downtrend is not complete. A drop below .9647 would complete 5 waves from 1.3285 and give way to a bottom and reversal. Until then, there is no reason to call a bottom because there is no evidence of a bottom. A bearish bias is warranted against 1.0624.
