In fairness, rumours that started last week about the central bank planning to raise the floor from SFr1.20 to SFr1.22 were met with a fair degree of scepticism. The fact that EURCHF finally woke from its slumber and put in the strongest rally in six months last week was a reflection of optimism about European Central Bank (ECB) president Mario Draghi’s plans to tackle the eurozone debt crisis with its new bond-purchasing scheme.
However, in truth, and despite the rally in the euro, there still remain implementation risks to the ECB’s plans, not least the fact that Spain has not asked for assistance from its eurozone partners.
So it stands to reason that the SNB felt it would be premature to raise the floor and risk some new calamity in the eurozone, which would see the euro plummet and its FX reserves – close to 70% of Swiss GDP – balloon higher as it defended the new level.
In the event, the SNB left its minimum exchange rate in EURCHF unchanged at SFr1.20, vowing to continue to enforce it with the utmost determination and pledging its commitment to buying foreign currency in “unlimited quantities” to achieve its goal.
The central bank also lowered its inflation and growth forecasts, saying that partly reflected the fact a depreciation of the Swiss franc had failed to materialize as expected.
Admittedly, that keeps the notion alive that the SNB could, at some point during the next year, raise the peg to protect its slowing economy.
However, for now, the SNB believes it is too soon to move.
Geoffrey Yu, FX strategist at UBS, says the market was clutching at straws if it believed the SNB would raise the floor. He says nothing has changed in the eurozone, given that Draghi’s plans are so dependent on exogenous factors.
“What if the SNB raises the floor and then Spain decides it does not want to play ball?” he asks. “That’s too big a risk for the SNB to take.”
Yu says those looking for a raise in the floor were merely trying to justify supporting long EURCHF positions. “They can’t be making much money,” he notes.
Indeed, there has been a marked shift in EURCHF positioning since Draghi first announced in late July that he would do all he could to ensure the survival of the euro.
Citi’s positioning indicator, for example, has moved from very short in late July to moderately long. Meanwhile, price action in the option markets further suggests investors are positioning for a move higher in EURCHF.
Citi has an equation for where EURCHF might be trading in the absence of a floor. It runs off the spread between Swiss and German two-year bond yields, Spanish credit default swaps and EURUSD. The bank says the improvement in eurozone conditions during the past six weeks has been so dramatic that those factors suggest EURCHF could justifiably be above the floor, even without SNB buying, for the first time since January.
| EURCHF - actual and projected |
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| Source: CitiFX, Ecowin |
Steven Englander, global head of FX strategy at Citi, says a big move in the SNB’s floor would represent a bet from the central bank that eurozone developments will continue in a favourable direction.
He warns that – as was the case in early 2012 – favourable conditions can rapidly become unfavourable.
“A big shift [in the SNB’s EURCHF floor] does not seem desirable because their exposure to a turnaround would become even larger, were eurozone conditions to slide again,” says Englander.
“The higher floor is neither necessary for EURCHF to strengthen if conditions continue to improve, nor is it sufficient to avoid pressure if conditions deteriorate again.”
The SNB are aware of this. If optimism over the eurozone fades, expect the franc’s safe-haven status to shine and EURCHF to gravitate back to its SFr1.20 floor.