It seems that over the past few weeks the Swiss national bank has been delving into the currency markets, this is due to the trade tensions increasing resulting in the Swiss franc making some strong gains against other currency pairs.

In just over a month we have seen the CHF move from 1.11 against the Euro to just below the 1.09 level in the last few days. This strength in the Swiss franc has been reciprocated against most of the other major currency pairs due to the risk off environment we have seen as of late.

The risks we have at play here are causing pairs such as the Swiss franc and Japanese yen to strengthen as investors and traders move their money into safe haven assets (make sure to take a look at gold prices over this period also as another safe haven asset).

With the US and China trade war continuing to escalate and the continuing slowdown we can see in economic data releases, as well as the expectations of monetary easing in the eurozone it is no wonder we are seeing such gains for the CHF and it doesn't look like there will be any respite anytime soon, however with the EURCHF price hovering around the 1.09 level it seems the Swiss national bank is starting to intervene.

Why and how the SNB intervene?

EURCHF currency pair

When the Swiss franc increases in value and particularly when it approaches the 1.09 level (the red horizontal line in the chart above) the SNB will start to worry and you start to hear murmurs regarding their intervention into the currency market to make sure the CHF doesn’t decline any further and if you look at the EURCHF chart closely you will start to see a small consolidation right at the 1.09 level which indicates some buyers around there (SNB?).

We can also start to see the SNB’s intervention in the currency market through their sight deposits which normally acts as a proxy for when they start purchasing foreign currencies, these sight deposits have significantly increased over the last two weeks as you can see in the graph taken from Bloomberg below which shows the sight deposits in relation the EURCHF exchange rate. From this we can tell that the SNB is starting to purchase foreign currencies against the Swiss franc in order to try to weaken the currency.

Here is the Swiss National Banks description of Sight Deposits and its roles:

"In order for a bank to maintain its solvency, it must have sufficient liquidity at all times. A bank's most liquid assets are sight deposits held at the SNB, since they can be used immediately to effect payments and are deemed to be legal tender. Domestic banks hold sight deposits to satisfy minimum reserve requirements. Banks also need them for payment transactions and as liquidity reserves. The SNB influences sight deposits through the use of its monetary policy instruments. Liquidity adjustments between the individual financial market participants are effected on the money market. Banks seeking to place funds on a short-term basis provide liquidity in the form of a loan to other banks that require short-term refinancing. These loans can be granted on a secured or unsecured basis. The level of sight deposits influences activity on the money market. A disruption in the money market impairs the liquidity adjustment process between the market participants and can threaten the solvency of the banks.."

SNB sight deposits hit a new peak in 2019
Source: Bloomberg

But why would the SNB want to weaken their currency? Well this all comes down to trying to kick start their economy and revive inflation, at the moment Switzerland is a country with one of  the lowest interest rates in the world which currently stands at -0.75% and with inflation continuing to fall (currently at 0.3%) there seems to be a dim outlook for the Swiss economy.

If the SNB can achieve their goal of having a weak Swiss franc this will allow for their exports to be cheaper and more attractive to foreign economies which will in turn help to stimulate growth which is why the SNB will do all they can to ensure the Swiss franc does not strengthen too much as it could be disastrous for their economy.

If the currency continues to strengthen against a backdrop of political uncertainty and a negative global outlook despite the SNB’s interventions then its only option may be to cut interest rates, however the SNB likes to surprise the markets and if they were to cut I would not expect there to be any prior warnings and so it will be important to carefully manage any Swiss franc trades during the coming months to protect against any sudden interest rate cuts, so keep a close eye on Swiss data.

What do we expect?

Now this is the difficult part, predicting what central banks will and won’t do is hard enough and almost impossible when it comes to the SNB. To understand more about central banks check out our break down here!

However here at Top Traders we aren't in the business of trading data or news releases as we get them, we want to build a picture of the environment we are trading in to make the best informed decisions when entering the markets, so what is the picture we have in regards to the Swiss franc?

A currency that has continued to strengthen due to ongoing uncertainty in the global economy, a central bank that is not shy in intervening to stimulate their own economy and a currency index approaching highs it has only seen 4 times since 2007 (including two massive spikes).

Swiss Franc Currency Index
Franc Currency index across the 7 majors

My analysis suggests that we could expect a sharp pull back soon either due to the SNB purchasing foreign currencies or a rate cut that will catch the market by surprise, however I feel the retracement will not last for too long unless we can see a pick up in the global economy and that means the US and China coming to some sort of resolution in the ongoing trade war which unfortunately I don’t see happening anytime soon.

August 11, 2019
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