FX Weekly – Dramatic action by SNB

by: Georgette Boele , Roy Teo

FX-Weekly-16-January1.pdf ()
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The Swiss National Bank discontinued the floor in EUR/CHF. This had a dramatic impact of the Swiss franc which strengthened by 14% on an effective exchange rate basis. The euro felt the largest impact, because it lost an important buyer. Meanwhile, currencies of Central and Eastern Europe also moved lower because of fears of a negative impact of CHF-denominated loans on their economies. The Japanese yen was next to the Swiss franc most in favour on safe haven buying.

Swiss National Bank dropped a bombshell…

The Swiss National Bank announced on Thursday a discontinuation of the minimum exchange rate of 1.20 in EUR/CHF and lowered interest rates by 50bp to -0.75%. This action took financial markets completely by surprise. There were some local media reports speculating in this direction last week, but investors had remained convinced in the SNB’s commitment to defend the floor.

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… resulting in a dramatic market reaction

The market reaction was dramatic. At some point, the Swiss franc gained more than 27% versus both the US dollar and the euro. Afterwards, it gave back some of these gains. The collapse in EUR/CHF reflects that substantial stop losses were triggered below 1.20. Investors had taken for granted that 1.20 in EUR/CHF would not be broken.

Change in outlook for the Swiss franc

In the near-term we expect the SNB to try to stabilise the Swiss franc via even lower interest rates, quantitative easing or FX intervention. If yesterday’s announcement is of any guide, the SNB will probably not take the FX intervention road. Taken the recent price action into account, it is safe to say that the majority of stop losses and option barriers have been taken out. So another wave of Swiss franc strength will come from investors actively buying the Swiss franc and taking new positions. This will most likely happen in the coming months. So after some kind of stabilisation, Swiss franc is likely to strengthen. We are obviously reviewing our current forecasts and we communicate these next week.

More pressure on EUR/USD…

With the SNB discontinuing the floor in EUR/CHF, the euro lost an important buyer in the market given less intervention by the SNB to buy euros in particular. Before and after the SNB announcement, the pair moved from being close to 1.18 to below 1.16. We also expect further downward pressure on EUR/USD on top of the other negatives. We expect the ECB to announce a QE programme on 22 January. As the period of US Fed quantitative easing showed, quantitative easing will remain a negative force for the currency as long as the program will remain in place. Therefore, the euro will continue to feel the impact of ECB QE. Moreover, growth and monetary policy divergence across the Atlantic will also remain a negative force for EUR/USD going forward. Our year-end target for 2015 and 2016 are 1.10 and 1.00 respectively.

 …but global growth worries support the yen

The Japanese yen gained about 2% versus the US dollar in the past week due to several drivers. First, concerns of slower global growth have supported profit taking of short positions in the yen. Second, narrower interest rate differentials between the US and Japan also exerted downward pressure on the US dollar against the yen. Third, positive spill over effects on the yen as investors unwound carry trades (triggered by the surge in the CHF). Besides the Greek elections on 25 January, China’s 2014 Q4 GDP number will also be crucial drivers for the yen in the week ahead.

The Canadian dollar extended its loss in the past week for the 8th consecutive week, as crude oil continued to decline. Earlier in the week, business sales optimism also fell to the lowest level since 2012 as the sharp decline in oil pushed business sentiment lower. Indeed, we do think that the Bank of Canada will adopt a slightly dovish stance in the next monetary policy meeting on 23 January. Indeed since the beginning of this year, the market has slowly priced out any probability of tighter monetary policy this year, a view consistent with our own.

Lower oil prices and central bank actions impact emerging market currencies

At the start of the week, weakness in oil prices had a direct impact on emerging market currencies. For example the South Korean won (KRW), Taiwan dollar (TWD), Indian rupee and Singapore dollar were beneficiaries of lower oil prices given that these economies are large net importers. On the other hand, the Russian ruble was the worst performing currency again.

RBI surprised with inter-meeting rate cut

The RBI lowered its benchmark rate by 25 bps, to 7.75% in an unannounced interim meeting and cut some other policy rates too. The timing of the move was surprising, but we had expected the RBI to cut rates soon. With inflation being pushed down by falling commodity prices – trickling down into core inflation as well – the difference between the repo rate and CPI had risen to 300 bps. The RBI already signaled a shift to an easing bias in late 2014. The RBI had been on hold since January 2014, after having prudently hiked rates during the Fed tapering-related turmoil in 2013 and early 2014. This move supported the Indian rupee.

Further easing to come

Going forward, we expect further ‘measured’ easing in China, India and South Korea and also see some room for easing in a number of smaller countries. In general, though, the room for easing is constrained by possible contagion from Fed rate hikes foreseen from mid-2015 onwards.

Currencies of Central and Eastern Europe under pressure

Last week, currencies of central and eastern countries were out of favour for two reasons. First, fears of the negative impact of a weaker Russian economy on these countries. Second, the sharp rise in the Swiss franc triggered concerns about the impact of CHF-denominated mortgage loans on their economies.

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