When it comes to a simply horrible FX forecast track record, nobody beats Goldman's Thomas Stolper, who for the longest time was beating a drum that the EURCHF is fairly valued at 1.44 (and still does). It only took a massive central bank intervention (and one which will fail shortly, just as it did a year ago), to get the pair halfway to his target, and by the looks of things, even the 1.20 support will be breached quite soon, once the SNB's balance sheet loads up with a few hundred billion worthless EURs and Switzerland realizes that the trade off of exports for German dominance (and US the year before) is not worth it. That will take place in a few days to weeks. In the meantime, here are two opposite takes on what will happen in the meantime: the first, appropriately enough, from Stolper, who again beats the 1.44 EURCHF drum, and the second, a cartoon from Alex Gloy of Lighthouse Investment, which summarizes the "downside" case.
The SNB committed this morning to a minimum EUR/CHF exchange rate of 1.20. Such a one-sided commitment implies a willingness to undertake unlimited CHF selling intervention and hence unlimited FX reserve accumulation.
This is a credible policy as long as the authorities are prepared to accept the liquidity implications of this potentially very large intervention. However, given the SNB’s recent commitment to oversupply the CHF money markets with liquidity, the new policy mix is consistent and can potentially be maintained until inflationary pressures materialise. Given the substantial overvaluation even at EUR/CHF 1.20 (GSDEER fair value is 1.44) and the anecdotally-observed declines in import-related retail prices, the risks of rising inflation seem remote currently. Political support for this measure is much higher now than last year, given the extreme moves in the CHF in recent months. This likely implies a stronger commitment than during the 2010 intervention.
Beyond the immediate impact on the CHF, the FX market may be influenced by SNB reserve allocation decisions. Most intervention will likely take place in EUR, and hence there could be the need to diversify the newly accumulated reserves into other currencies. The SNB followed this strategy after the last round of EUR/CHF intervention in the 1.50 area. According to the SNB's latest Annual Report, the currency breakdown of FX reserves is EUR 55%, USD 25%, JPY 10%, GBP 3%, CAD 4%, Other (DKK, AUD, SEK, SGD) 3%.
In theory, this diversification could put some downside pressure on other EUR crosses. However, the diversification impact should not be over-emphasised. First, there was no notable FX market impact of the diversification in the second half of 2010, which followed a sizable increase in SNB FX reserves of more than CHF100bn. Second, the diversification move can be spread out over time and be delayed by months after the underlying intervention.
Overall, we therefore expect the impact on FX markets of today’s announcement to be limited to the Swiss Franc.
And, the flip side, from Alex Gloy: