Sudden deprecation of the CHF has fueled speculation of SNB action. However at this moment there is no evidence of official SNB intervention. Most likely the sudden move was the result of low liquidly conditions and exceptions for the SNB action that forced participants to react. Better to adjust your trading book then to get caught flat-footed by the SNB.
Given amplified expectations for a lower ECB deposit rate, there are heightened risks that the SNB will defend appreciation pressure on the CHF with further policy actions. It’s critical to understand that the recent improvement in Swiss economic data is a direct result of 5% weakness of the CHF against the EUR. The recovery remains fragile (Kof is on the edge of expansion and contraction) and conditional on developments in exchange rates. In recent weeks, the SNB has ramped-up its readiness to combat CHF appreciation and is not unlikely to let prices naturally evolve. In our view, the SNB has three primary tools at their disposal (listed in order of likely activated), verbal intervention, cutting interest rates, closing exemption thresholds and FX interventions. As with the ECB, there are more exotic measures the SNB can use but in our view the effectiveness will be marginal and therefore unlikely to be enacted.
We still suspect that verbal intervention remains the SNB most powerful tool and first line of defense. We anticipate an intensification of rhetoric prior to any action. Agreed, the expansion of the central bank’s balance sheet of the last 7-years has eroded the market’s fear of substantial FX intervention. Currently the monetary base is over 70% of GDP and foreign currency reserves account for around 88% of total assets. However, the bite of the SNB’s past and current aggressiveness can still be felt by many FX participates (including our Bank). In our view even a restricted SNB carries weight.
The SNB cannot afford to let interest rates spread between the EUR and CHF widen. SNB speeches have clearly identified the importance of interest rate differentials on flows and therefore will ensure spread remains constant. According to Thomas Jordan "The SNB is ready to intervene, if necessary. The deposit rate could go lower." The SNB's next quarterly monetary policy assessment is on December 10th before or at this meeting our expectations are for a 20bp reduction (matching the ECB cut in deposit rate) in the mid-point of the 3-month LIBOR target rate, from -0.75% to -0.95%.
Currently negative interest rates only affect a select group of depositors. Currently the SNB charges sight deposits holding over 20 times each bank’s minimum reserve requirements. Lowering exemption threshold would affect banks differently and it would be uncertain that the lower rates would be passed to depositors causing the desired outflows result. In addition, domestic savers are unlikely to be forced to shift currency deposits, resulting in the erosion of bank profitability.
Finally, direct FX intervention would be the most persuasive tool in the SNB arsenal but would need to be used with discretion. Jordon stated on Thursday that there was “no limit” to the size of the SNB balance sheet. In theory this is correct but in practice is not so “unlimited”. The SNB is unlikely to risk destabilising the nation by become a giant FX hedge fund only to protect the CHF. Massive loses on FX reserves and effect on dividend payments to cantons has damaged the Swiss public resolve to protect the CHF.