FX markets are not really helping the Swiss national bank’s problem with an overvalued CHF. While the CHF depreciates against the USD it has gained against the EUR. However, for the SNB it’s the CHF position vis-avis the EUR which matters most. Finding itself entrenched amid current Swiss economic conditions which are broadly deteriorating and deflations, the SNB needs the CHF in a competitive position with its largest trading partner. Recent marginal improvements in data were driven by CHF deprecation which has now reversed.
ECB President Mario Draghi’s dovish comments clearly signal that December will at least open the discussion for QE expansion. However, actually actions are highly probable. We anticipate not only lengthened asset purchases but further cuts to the deposit rate. Lower interest rates in Europe will have a direct effect on capital flows into Switzerland.
In September, the SNB held off acting, leaving sight deposits rate lower boundary at -0.75%, despite dropping the inflation forecast, choosing instead to stand ready to react to the ECB’s potential policy actions.
The SNB has two primary tools to handle further ECB easing and CHF strength. The banks can further reduce interest rates (first tightening current deposit rates loopholes) and/or direct currency intervention. While the SNB will never fully abandon currency purchases, the likelihood of significant FX intervention remains a low probability as the SNB balance sheet has expanded into unsettling territory. Swiss policy makers have been vocal in recent weeks highlighting the importance of negative interest rates on sight deposit as a policy tool. On November 3, the SNB president mentioned negative interest rates as a primary monetary policy strategy to ‘dampen upward pressure on the Swiss franc.’ The Swiss economy remains fragile indicating that the SNB will defend the CHF from further overvaluation against the Euro. Given the Bank’s track record of inflicting as much damage on CHF longs as possible, heading into December, CHF traders should be wary of potential aggressive action.