2013 was a great year for the Swiss Franc. Of the major currencies, it was one of the best performing, second only to euro. The Swiss National Bank successfully maintained its 1.20 EUR/CHF peg for the second year in a row and even managed to drive EUR/CHF up 1.6%. While EUR/CHF and USD/CHF moved less than 3% this year, the Swiss Franc appreciated over 15% against the Australian dollar and Japanese Yen. In 2014 we expect much of the same for the Franc with EUR/CHF trapped a tight range as the SNB leaves the peg in place for another year.
Reaping the Benefits of the 1.20 EUR/CHF Peg
The 1.20 EUR/CHF peg was established in 2011 and this year, Switzerland reaped the benefits. Annualized GDP growth accelerated from 0.8% in Q1 of 2012 to 1.9% by Q3 of 2013. For the year as a whole, the Swiss National Bank expects GDP growth to hit 1.8% and accelerate to 2.3% in 2014. Low unemployment has fueled ongoing strength in consumer spending and with the global economy expected to recovery next year, the State Secretariat for Economic Affairs (SECO) sees “good prospects for a strengthening economic upturn in Switzerland over the next year.” While exports to the Eurozone was held back by weak growth, manufacturing activity improved consistently throughout the year, boosting the trade surplus to 2.11 billion in November from 0.88 billion in December 2012. According to the PMI report, the manufacturing sector expanded in all but one month in 2013, a significant improvement from the back-to-back contraction in 2012.
Why the 1.20 Peg Will Remain in Place
Despite clear signs of growth, low inflation makes it impossible for the SNB to change the 1.20 EUR/CHF peg. As of November 2013, consumer prices grew at an annualized rate of only 0.1%. While this represents a significant improvement from the -0.6% rate in April, it is far shy of the central bank’s 2% target. With no room to cut interest rates, the SNB’s FX policy is one of the few ways to drive up prices. In order for the SNB to consider dropping the EUR/CHF peg, CPI needs to be closer to 1.5% and ideally 2% but in 2014, it is estimated by SECO to gain only 0.3%. At the same time, the central bank can’t raise the peg to encourage a faster increase in inflation because credit is tight and the housing market is growing too quickly. By raising the peg, the SNB would effectively be increasing stimulus and this could create a bubble in housing. Instead, the government will cool real estate by raising capital requirements and lending rules.
Will the Swiss Franc Regain its Safe Haven Status?
Switzerland’s FX peg stripped the Franc of its safe haven status and now many investors are wondering whether it will ever become a safe haven again. Since we believe the global economy will strengthen in 2014, the more interesting question to ask is whether the Franc will become a funding currency but if there is an exogenous shock that creates a flight to quality, demand for the currency will still be capped by the fear of SNB intervention. Since the aggressive intervention in 2011 discouraged investors from buying the Swiss Franc, as the global economy recovers there may not be much unwinding of long franc safe haven trades. At the same time even though the combination of stronger global growth and a floor in EUR/CHF makes the Franc an attractive funding currency, the country’s massive current account surplus will create offsetting flows that will limit the rise in EUR/CHF.
This means we expect EUR/CHF to trend higher this year but the gains will be limited. The best strategy would be to fade big moves at the extreme ends of the 1.20 and 1.26 range. EUR/CHF could be driven lower if the European Central Bank eases monetary policy in the coming year but even if this dramatic decision is taken, the gains are not expected to last because at most the ECB has only one more dose of easing left in them before they shift to neutral. EUR/CHF could be driven higher if the outlook for the Eurozone improves significantly but any upside will be capped by a stronger trade surplus and growing investment income for Switzerland. The performance of currency pairs such as USD/CHF, AUD/CHF and CHF/JPY will be determined by the market’s appetite for the other currency.