Showing posts with label CHF. Show all posts
Showing posts with label CHF. Show all posts

Sunday, January 25, 2015

25/1/15: Swiss Out, Danes In: Pegs and Euro Mess


My comment from earlier this week on SNB and Denmark's Nationalbank pegs decisions (Expresso, January 24, 2015 page 09):

There are two truths about currency pegs.

The first one is that no Central Bank is an island. In other words, all pegs are temporary in their duration and costly in their nature, while held.

The second one is that exiting a peg with underlying conditions similar to those when the peg was set in the first place can never be a smooth and risk-free decision. Disruptive nature of such an exit is only highlighted by the necessity of the peg in the first place.


Swiss CHF to Euro peg is emblematic of the above two facts. The peg, de facto maintained from the summer 2011 (but officially launched on September 6, 2011) at the height of the euro area crisis, was designed to remove pressures on the Swiss Franc arising from the rapid acceleration of capital inflows from the euro area to Switzerland. The resulting inflows pushed values of CHF well beyond the sustainable bounds, threatening to derail the Swiss economy, heavily dependent (especially in 2011) on exports.

The cost of the SNB peg to the Swiss economy was manageable, but accelerating in recent months. As part of the peg, SNB printed CHF to purchase surplus euros. Bought euros were accumulated on the SNB balance sheet. recent devaluation of the euro against the US dollar, and expected future devalutations of the euro (on foot of upcoming ECB QE measures) pushes down the real value of these forex reserves accumulated by the SNB. Exiting the peg simply realigned these values to actual currency fundamentals and crystallised the loss in one go, de facto partially sterilising the inflows.

Chart below illustrates accumulation of Forex reserves by SNB from the peg introduction on September 6, 2011.



The disruption caused by the SNB exiting the peg has been significant. Some 46 percent of all Polish mortgages have been issued in CHF. Hundreds of thousands of loans in other Eastern European countries were tied to CHF as well. The cost of funding these loans rose by between 15 and 20 percent overnight, causing some panicked reactions from some Eastern European Central Banks. Beyond this, home-felt impact of SNB move has been less pronounced in the short run. However. in the longer term, stronger Swiss Franc is going to put severe pressure on Swiss exports and will likely result in deterioration in the overall balance of payments. Swiss economy is still heavily reliant on Forex valuations to support its global trade. Current world trade conditions - with the likes of Baltic Dry Index at 753,000 close to crisis period lows, and IMF projections for ever lower rates of global trade growth in 2015-2016 - all signalling serious pressures on Swiss exporters.


Denmark's decision to introduce a Krone/Euro peg this week is likely to fare about as well as that of the Swiss decision in 2011. Just as the Swiss, Danish regulators also set negative deposit rates to further reduce pressure on Krone from Euro inflows. However, the pressure on the Krone is rising not due to the crisis-related capital flight (as was the case with Switzerland in 2011-2013), but due to currency hedging in anticipation of the ECB quantitative easing move expected to be announced this week.

Danish peg is critically different from the SNB previous attempt to peg CHF. The reason for this is that Krone has a long-term link to the Euro and in effect current peg is simply a form of repricing this link. And, unlike CHF (which accounts for roughly 5.2 percent of global currency trading volumes), Krone is a relative minnow in the forex markets (its share of the global currency trade is only 0.8 percent).

The two factors make Krone peg more credible and less costly to defend over the medium term. But none of these factors help to alleviate the problem of currency valuations for Danish exporters, who will see their markets for exports more contested now that the Krone is appreciating against the Euro.



The reserves dynamics preceding the Denmark's peg introduction and the SNB peg announcement in September 2011 are similar: both currencies have sustained heavy 'buy' pressures and both pressures were driven by the crises in the euro area. SNB introduced the peg at relatively benign levels of forex reserves accumulation back in 2011 which, at the time, were nonetheless consistent with crisis-period peak levels. Denmark's Nationalbank's peg introduction also takes place close to crisis period peak of reserves accumulation and the question to be asked is: how much pain on DKK can Denmark take in this environment. 

Monday, September 12, 2011

12/09/2011: CHF and the "soon-to-be-busted" peg

Some weeks ago I have addressed one of the core reasons why the CHF/Euro peg, announced last week by the SNB will not hold for longer than 1-2 months. Here are the previous links to:
  1. Small Open Economy argument (link)
  2. Small Open Economy as safe haven argument (link)
Since then, in last weekend comment to the Sunday Times, I outlined another core reason for the peg to fail - the SNB has been brandishing the war chest of some USD 230 billion of FX funds that it says will be delivered into the battle field to support CHF, should pressures on CHF/Euro cross continue to mount. Now, that number above is roughly 1/2 of the Swiss 2010 end-of-year M1 money supply.
  • Imagine the scale of intervention and the resulting interest rates hikes that will be required to extinguish inflationary pressures arising from this?Up by 50-100%?
  • Now imagine what will happen with CHF cross with the euro if the interest rates in Switzerland were to, say, rise by 50-100%? Correct - demand for CHF will go through the roof, undoing any CHF/euro supports erected before.
  • And alongside this, imagine what the 50-100% increase in interest rates do to capital investment and corporate balancesheets in Switzerland? Again correct - corporates, spared by SNB peg from being destroyed by the exchange rate appreciation will now face the very same FX pressures as before, plus higher cost of capital
And now, folks, for the third weighty reason why SNB will be forced to abandon its peg. Medium-term promise of a devalued CHF coupled with zero interest rates (0-0.25% on 3mo Libor target against Euribor 1.56% comp) implies a huge incentive for carry trades origination in very short term run, while in the medium-term, expected long-term revaluation of the CHF creates an incentive to make carry trades very short-lived. Both are not so much the forces to drive demand up, but the forces to destabilize fundamentals-determined medium-term FX rates.

Good luck betting that CHF peg holds, my friends...

Wednesday, August 3, 2011

04/08/2011: Safe Haven within a small open economy

Some interesting news flow on the Swiss Franc side today with the Swiss National Bank announcing that it will intervene in the markets across not just one instrument, but three, simultaneously. CHF had seen dramatic appreciation against the Euro and the USD in recent months (see charts below), with current valuations of CHF, according to SNB: "threatening the development of the economy and increasing the downside risks to price stability in Switzerland."

In line with this, SNB announced that it will (1) move target 3-mo Libor rates closer to the range of between 0% and 0.25%, down from the current range of 0% to 0.75%, (2) will "very significantly increase" the supply of CHF, and (3) will hike required deposits for Swiss banks from CHF30 billion to CHF80 billion.

Funny thing, folks, shortly after the announcement, CHF fell against the Euro by 1.8% to CHF1.1061/Euro, and against the dollar +1.4% to CHF0.7761/USD. Yet, with the latest rumors from the US - about QE3 - the USD promptly fell back against the CHF to 0.7701/USD and erased most of the euro gains to CHF1.1054/Euro.

The problem, of course, is that for all the firepower deployed, SNB has little power to shift the prevalent investor sentiment that, at the time of expected QE3 and continued uncertainty about the Euro area sovereigns, CHF - alongside other small currencies - represents, in the minds of investors, a safe haven. This, of course, is the dilemma of the Swiss franc - a safe haven within an small and open economy: too well-run to join the basket cases across its borders, too small to defend...

And so to end with some good background on what's going on with CHF recently - read this.