How low can the CHF go?

The potential for a further fall in the CHF/EUR exchange rate seems limited – a discussion on the likely targets for the CHF exchange rate and the factors supporting positive forecasts. 

The EUR/CHF exchange rate is already nearing its neutral valuation band. Forecasts indicate that strong Swiss fundamentals and limited incentive for capital outflow will limit further CHF weakness.

The decline of the perceived euro area risk premium has helped drive the strength of the EUR in recent months. As the CHF is richly valued on most measures, this has fed through to EUR/CHF strength in particular. The Swiss National Bank (SNB) has thus been able to reduce its intervention volumes, as the CHF’s softness has been driven by private capital flows, taking the place of central bank EUR buying.

Unwinding of hedges influencing CHF exchange rate

Although the positive trend for the CHF is encouraging, it is not clear that this development represents a sustainable shift in Swiss investor preferences for unhedged euro assets. It is likely that large parts of the recent moves are related to an unwinding of hedges against political and other risks that could have caused CHF strength (or, in fact, EUR weakness).

Indeed, it is hard to argue that the fundamental attractiveness of EUR assets has moved significantly in the EUR’s favor, as both the Swiss and the Eurozone economy have enjoyed a strong upswing in leading indicators. While the German Bund yield has risen from a low of -0.17% to around +0.40%, the Swiss bond yield has moved from -0.60% to near zero.

Forecasts show a potential dilemma for the SNB

As short-term capital flows ease, the SNB may face a dilemma. Should it resume interventions at the now higher EUR/CHF spot exchange rate and risk expanding its balance sheet again, or should it allow EUR/CHF to fall back to lower levels where private capital flows may provide an equilibrium with lower or even no volumes of central bank support?

There is no doubt that the SNB would prefer to see EUR/CHF hold higher levels, but with the economy strong, it is not clear that this outcome is desired with the same commitment to balance sheet expansion. In this sense, the SNB, like all major central banks, can be seen as moving closer to a conceptual tapering of its liquidity expansion at any exchange rate.

The burden of this dilemma is that the CHF exchange rate will face limited downside potential as long as the most basic fundamental drivers of capital flows have not materially changed. Already, the rise in EUR/CHF this year has taken the exchange rate close to the lower boundary of the estimated neutral valuation band, around CHF 1.16 per euro (see chart). A sustained return to fairer CHF valuations will likely depend on a more durable rise in global yields and global risk appetite.

CHF weakness now has limited potential

The recent EUR/CHF surge can be seen as more of a large-scale position adjustment than a fundamentally driven change. Therefore, forecasts indicate that projected overhead resistances at 1.1500 and, in extremis, 1.1800 will overshadow this move ‒ all the more so as CHF valuation will turn to neutral above 1.16 vs. the EUR.

A broad range under these levels can be expected to persist until year-end given that the current momentum should give way to correction as long as the European Central Bank’s policy remains extremely easy. As such, there would appear to be limited potential for CHF weakness. The SNB will likely remain highly vigilant and ready to defend against any rapid CHF strength.

Fair value EUR/CHF

Fair value EUR/CHF

Last data point: 09/08/2017. Historical performance indications and financial market forecasts are not reliable indicators of current or future performance. Source: Bloomberg, Credit Suisse / IDC