Investors with a strong stomach could find safe haven in the franc

Kathleen Brooks
AMID all of the turmoil gripping the European Union in the wake of Greece, Portugal, Spain and Ireland’s debt problems, Switzerland – which is not a member state – has remained fairly trouble free. The contrast between
Europe’s woes and the relative calm of the economic outlook in Switzerland has been played out in the currency markets: the Swiss franc has appreciated nearly 10 per cent against the euro since the start of 2008.

Part of this appreciation is down to the franc’s traditional status as a safe haven currency – investors flock to currencies such as the franc when they become risk averse, because of the perceived stability of its economy. As the euro has tumbled on Greek woes, the franc has risen to its highest level in nearly a year.

But the Swiss National Bank (SNB) could throw a spanner in the works of further franc appreciation. It announced at its monetary policy meeting last month that it would not tolerate “excessive” appreciation of the franc, and there have been rumours that the central bank intervened to weaken the franc on Friday after it surged to SFr1.46 per euro.

Antje Praefcke, senior FX strategist at Commerzbank, says the central bank made it clear at its last policy meeting that it will not tolerate a speedy appreciation of the franc. So, when the currency breached SFr1.50 per euro at the start of this year (a well known technical level suggesting more franc strength) the Bank did not intervene. It waited until it saw rapid appreciation at the end of last week. Praefcke says the Bank is likely to intervene further to limit appreciation past SFr1.45, as this is what she calls the Bank’s “maximum pain threshold.” Below SFr1.45 the euro-Swiss franc exchange rate has fewer technical levels and the Swiss currency could gain more upward momentum.

The prospect of central bank intervention is a timely reminder that a long position in the franc is not going to be a sure-fire bet. Some analysts argue that the central bank will cease intervention in the forex markets later this year, including BNP Paribas FX strategist Ian Stannard, because it is also trying to remove liquidity measures put in place during the economic crisis. For example, the SNB started removing its US-dollar swap facilities at the start of this month. Withdrawing stimulus while at the same time intervening to keep the currency low is counter-productive, since a weaker currency is another form of economic stimulus.

Another reason to back the franc is that the economic recovery seems to be picking up momentum. Swiss economic indicators have continued to move higher, suggesting that the recovery will continue. Although inflation rates remain low, Switzerland is at risk from inflation later this year because the output gap (the difference between the actual output of the economy and its potential output) has narrowed compared to other G7 nations and the unemployment rate, although at a 10-year high, remains low at 4.4 per cent.

So, there is a strong case for further Swiss franc appreciation based on its status as a safe haven and a strong economic recovery this year. But investors need to make sure they keep an eye on the SNB and listen out for rumours that it’s not happy with Swiss strength.