Research Update: The SNB Moves to a Managed Float
In response to increasing appreciation pressure on the CHF, most likely due to the impending shift by the ECB to Quantitative Easing (QE), the SNB has abandoned the minimum exchange rate for EUR/CHF while further lowering interest rates.
In an almost completely unexpected move, the Swiss National Bank (SNB) announced today that it has stopped defending the minimum exchange rate for EUR/CHF that it set in September 2011 at 1.20. In addition, and to avoid "inappropriate tightening of monetary conditions," the SNB has lowered the target range for the 3-month Libor to between –1.25 percent and –0.25 percent from between –0.75 percent and 0.25 percent. The SNB has also boosted the negative interest rate it charges on commercial banks’ deposits to –0.75 percent from –0.25 percent. The SNB will, however, "remain active in the foreign exchange market to influence monetary conditions."
Swiss exports and export-oriented companies are likely to suffer a setback, and Swiss inflation will turn negative in 2015. The extent of these moves will depend on where the CHF exchange rates settle. We believe the SNB will continue to try to manage the currency by means of sporadic intervention. Given that the CHF has moved into overvalued territory, chances of success are fair.
Impending QE by the ECB the Main Trigger for the Move
In its statement, the SNB said that "divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced" and that "in these circumstances...enforcing and maintaining the minimum exchange rate for EUR/CHF is no longer justified." More concretely, the main reason that motivated the SNB’s policy change was, in our view, that the SNB felt uncomfortable with the risk that it would need to further expand the size of its balance sheet as the European Central Bank (ECB) moved to more aggressive quantitative easing. The SNB likely anticipated that the ECB would need to pursue this policy for a number of years given the weakness of the Eurozone economy. With more monetary easing in the Eurozone, the SNB understood that it would likely need to engage in continued currency purchases (i.e. parallel QE) to maintain the exchange rate floor. In our view, the SNB thus decided to "take the hit" to its balance sheet now, rather than at a later point in time when the balance sheet would possibly be much larger. The experience of the last weeks in which the CHF failed to weaken in response to negative interest rates must have been an added trigger.
Strengthening World Economy and Stronger USD Reduces the Risk
At the same time, the conviction that the world economy would continue on its expansion path probably eased worries of the SNB that abandoning the exchange rate floor would seriously damage the Swiss economy. Of great importance is the fact that the US economy looks very robust and that the USD and some currencies linked closely to it would likely appreciate and thereby ease the pain of EUR devaluation.
Lower Growth and Temporary Deflation in 2015
On our estimates a 15 percent trade-weighted appreciation of the CHF (in combination with the rate cut) corresponds to an interest rate hike of two to three percentage points, i.e. monetary conditions in Switzerland have tightened considerably. While we will wait to adjust our detailed forecasts, we would expect inflation to drop by 1 percent to 1.5 percent in 2015 relative to our previous forecast of a 0 percent inflation rate. If the exchange rate settles at current levels (approximately 15 percent lower than yesterday), export growth could come to a standstill this year, implying that GDP growth could be 0.5 percent to a maximum of 1 percent lower than expected. However, given still good momentum in the domestic economy the risk of a recession in Switzerland looks very low to us.
Move to a Managed Float
Obviously, trying to forecast the next move of the SNB is extremely difficult. As historical and recent evidence suggests, driving interest rates even lower would probably have only a limited effect on the exchange rate. Moreover, both savers and banks would be damaged if the deposits affected would be wide-ranging. Hence, in our view, the SNB is rather going to continue to intervene in the foreign exchange markets if markets become very volatile and the CHF moves far away from what the SNB regards as a fair value. In effect, we believe the SNB will thus loosely target the trade-weighted exchange rate. This comes close to adopting an exchange rate basket as a target but without revealing its exact composition. The key currencies for the SNB will, of course, remain the EUR and USD. Given that our currency experts see the fair value of EUR/CHF at around 1.20 and of USD/CHF around parity, chances are that currency intervention will not need to be very large after today’s exchange rate adjustments.
Take-Away for Swiss Equities
The SNB’s decision has, of course, strongly affected Swiss stocks, given that most Swiss companies are strongly exposed to foreign markets. The transactional and translational currency impact on companies and stock prices can be substantial. Some firms hedge currency impacts but risks always remain. Reporting in USD or EUR also does not help, as earnings per share are calculated in CHF and are affected by CHF strength. The impact of the SNB’s decision on Swiss stocks is thus clearly negative.
Among financials, the pure Swiss private banks and the diversified financials will likely suffer the most due to their CHF cost base. Internationally diversified banks are slightly better positioned and the initial stock price movement is likely to have been an overreaction. Going forward, insurers will be exposed to the indirect effect of the low yield environment. Within the healthcare sector, we differentiate among large multinational firms, where currency risks are usually hedged naturally, and smaller firms, where this natural hedge is less likely.