Citi On The SNB Non-Intervention: Pegs Can't Fly, And Why FX Spot Market Intervention Is Not A Panacea
Citi's Steven Englander was proven 100% in his skepticism to the SNB's intervention. Here are his follow up thoughts:
- We think that the SNB is still largely reluctant to intervene on the FX spot market. Investors expecting such measures in the near term could be
disappointed in our view.
- The latest measures imply that the SNB will have to increase the size of its balance sheet by at least about CHF 40bn or 8% of the Swiss GDP
- FX spot market intervention is not a panacea and that the best that the SNB could hope for would be to prevent further CHF appreciation.
- While we could have seen the lows in EURCHF and USDCHF for now, we doubt that an uptrend in the crosses could be sustained.
Investors expecting FX spot market intervention very soon could be disappointed
The SNB announced today that it will extend its previously announced measures to combat excessive CHF appreciation. In particular, the bank extended the size of the banks sight deposits by further CHF 80bn to CHF 200bn and pledged to use FX swaps further. The latest measures imply that the SNB will have to increase the size of its balance sheet by at least about CHF 40bn or 8% of the Swiss GDP. This seems to be the case unless there is a conversion of central bank liabilities other than SNB bills and repos into sight deposits. In the absence of any purchases on the FX spot market, the increase in the balance sheet could be achieved by expanding the amount of FX swaps for now.
The initial market reaction was one of disappointment with both EURCHF and USDCHF heading lower following the announcement. The crosses recovered soon afterwards, however, with investors apparently thinking that, given the extension of SNB liabilities, it should be only a matter of time before the SNB starts intervening on the FX spot market. Market hopes for more policy measures ahead could keep EURCHF and USDCHF above recent all-time lows for now it seems.
We suspect that any indications later today that the Swiss Federal council is endorsing any further SNB measures to address the excessive franc strength could also limit the downside in EURCHF and USDCHF as they will underscore the resolve of the SNB. That being said, however, we doubt the Federal Council will go as far as endorsing specific measures. A more general statement will also highlight in our view that the SNB has still not exhausted other options that are at its disposal.
We think that today’s decision is an important indication that the SNB is still reluctant to intervene on the FX spot market and that investors expecting such measures in the near term could be disappointed. We maintain the view that a FX spot market intervention to keep CHF below certain target level is a measure of last resort for the SNB. We suspect that the SNB strategy remains to build a wall of supply to counteract any further escalation in the demand for Swiss franc. Today’s forward market intervention has pushed the CHF basis swap deeper into the negative territory (Figure1). A comparison with previous episodes of excessive market uneasiness like in 2010 and 2008 and may suggest that the SNB has not yet fully exhausted this policy option. We continue to think that the next policy step will be to impose penalty rates on CHF-deposits. The measure will augment the impact of negative CHF implied yields on investor demand for the currency.
FX spot market intervention is not a panacea
We certainly cannot rule out FX spot market intervention at some point in the future. We think that the SNB will resort to that measure if all other measures have failed. Even in this case, however, the SNB could face an uphill struggle dealing with the huge demand for CHF from investors looking to sell both EUR and USD. Triggering and uptrend by defending a one-sided peg could be very difficult given the very elevated
sovereign debt risks in the euro area. We still think that the best that the SNB could hope for at present it seems would be to stabilize CHF.
The FX spot market intervention has limitations especially compared to forward FX market interventions where the SNB could roll expiring swap contracts relatively easy. The SNB could pre-commit to printing a potentially unlimited amount of CHF to purchase foreign currency denominated assets. Yet, it could run into difficulties implementing the strategy given that a sustained market intervention may mean doubling the FX reserves assets which already stand at more than 30% of Swiss GDP. The SNB is likely to continue aiming at purchasing liquid AAA EUR-denominated assets. With the latest market concerns about the French fiscal outlook, the SNB may have little choice but to tap the liquid but already very expensive Bunds.
Given the huge Swiss CA surplus (14% of Swiss GDP) and net foreign asset position (130% of GDP) the inflow into CHF should continue to go beyond pure safe haven flows in coming months and quarters. Previously we have argued that a potential spot market intervention would be made more successful if the Swiss corporates abstain from repatriating earnings back home for now. One way to gauge the potential impact of any future earnings repatriation is to look at the net foreign direct investment taken from the Swiss balance of payments. As shown in Figure 2, the net FDI outflows seemed to average CHF 20bn per quarter before and after the 2009-2010 FX market intervention. The Swiss FDI outflows fell to zero during the intervention as Swiss corporates invested less abroad and looked to repatriate earnings and other capital.
Before embarking on any spot market intervention, the SNB is also likely to take into account the fact that there is still a substantial amount of CHF-denominated mortgages and other assets held outside Switzerland and generating inflows into franc. For example, the CHF-denominated mortgages represent the bulk of the EUR 53 bn of FX mortgages in Poland and Hungary. Our Bank strategists suggest that there are little indications of banking sector tensions in the two Eastern European countries. In turn, there need not be any near term pressure resulting in distressed selling of assets and inflow into CHF. That said, however, persistent CHF strength could make servicing these mortgages increasingly difficult.
[more on the last bolded sentence shortly]