The Swiss National Bank (SNB) stunned the FX market three weeks ago when it abandoned its CHF peg to the EUR without warning, sending the CHF sky high and EURCHF reeling. The initial reaction was a 20% drop in EURCHF, but since last week, EURCHF has been clawing back some recent losses, and is now at its highest level since the peg was dropped on 15th Jan.
EURCHF is back above 1.05 at the start of this week, so are we likely to make further gains and return to a new equilibrium for this pair?
The driver of today’s move higher appears to be reports in the Swiss press that the SNB will informally aim for a rate between 1.05 and 1.10 in EURCHF, although this hasn’t been verified by the SNB.
So why would the SNB do this and could it happen?
Below we look at the pros and cons for establishing a EURCHF corridor:
Pros:
- It may weaken the Swissie, which could help out Swiss exporters
- It could help fight deflation, since a strong currency can weigh on price pressures
- It could help the Swissie to find a new equilibrium after last month’s sharp, and in our view unsustainable, appreciation.
- The SNB could be cheered by the CFTC FX positioning data (see figure 1), which showed that although long positons in the franc have increased, the market is still net short the Swissie, and the reduction in Swiss shorts seems to have levelled off. If the SNB is thinking of weakening the Swissie, then momentum could be on its side.
- The SNB could help to smooth the flows in the Swissie and sooth excess volatility after last month’s move, which could help it to rebuild its reputation as a credible central bank.
- The bank has the mechanisms and infrastructure in place to do this; after all it kept an effective EURCHF peg for 2.5 years.
- It would cost less to keep a corridor between 1.05- 1.10 compared with an outright peg, which could help to protect its already bloated balance sheet.
Cons:
- If the SNB wanted to implement a corridor, why didn’t it do so on the 15th Jan when it disbanded with its peg? Did they shoot first and think later? Thus, this move may not help solve its credibility problem.
- The bank would still have a problem of an expanding balance sheet, it would also add to its huge pile of EUR’s.
- The peg could get expensive to defend if 1, Greece defaults or 2, Spain elects an anti-austerity party to the top levels of government later this year. Both of these events could dramatically weigh on the EUR.
- The ECB have just embarked on an open-ended QE programme and may need to embark on even looser monetary policy down the line if deflation lasts for some time. A corridor would re-tie SNB policy to ECB policy, since the SNB also cut interest rates to -0.75% on 15th Jan, further action to match the ECB policy step for step could be tricky for the SNB to achieve.
Conclusion:
Overall, a fresh peg or corridor cannot be ruled out from the SNB, but we think the timing is suspicious. Why would it not have announced it on the 15th Jan? While a corridor makes sense, it would still put the SNB balance sheet at risk and it would also tie the SNB to the ECB’s monetary policy stance when the European Central Bank has just embarked on an enormous, and open-ended, QE programme.
Our advice is to be careful if you are trading the Swissie in the coming days. The announcement of a corridor for EURCHF may initially cause the volatility in this pair to surge, as the market gets used to the new regime. But if the SNB fails to announce a new EURCHF policy then we could see the Swissie drift higher, so don’t get caught out. This could be a trade to avoid until we know the next steps from the SNB. With US payrolls coming out later this week there could be safer opportunities elsewhere.
Takeaway:
- The Swissie has been the weakest currency in the G10 for the past week, as some of the upward pressure starts to ease off.
- A rumour is brewing that the SNB may be about to implement a 1.05-1.10 corridor in EURCHF.
- Until we hear it from the horse’s mouth we are sceptical about this – why didn’t the SNB announce that on 15th Jan when it dropped its peg?
- The EUR still looks vulnerable due to problems with the periphery resurfacing once again, so implementing a corridor at this stage would be a brave move.
- Overall, until this rumour is validated or quashed, expect volatility in Swissie crosses.
Figure 1:
Source: FOREX.com and Bloomberg
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