FOREIGN EXCHANGE MARKET ANALYSIS

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In 2023, the Swiss franc continued to appreciate against its main counterparts : +10% against the US dollar and +7% against the euro (see Fig. 2). This trend accelerated at the end of the year when Forex traders began to anticipate an easing of monetary policy by the US Federal Reserve (Fed) and the European Central Bank (ECB) in 2024. As the gap between the low yields on Swiss bonds and their dollar and euro equivalents became less and less of a deterrent, the Swiss currency naturally appreciated (see Fig. 3).

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However, the fact that the Swiss franc has risen so sharply is not due solely to traditional interest rate dynamics. The strength of the franc is largely due to the strategic management of foreign exchange reserves. Last year, the Swiss National Bank (SNB) sold large volumes of foreign currencies, reducing its holdings from CHF 784 billion at 1st January to CHF 654 billion on 31 December (see Fig. 4). While this amount remains high in absolute terms, it is the lowest for seven years. In doing so, the SNB managed to kill two birds with one stone:

▪ Erase the money creation carried out during the Covid-19 crisis and thereby reducing its balance sheet.

▪ Mitigate the recessionary impact of soaring prices without having to raise key interest rates too much. With a strong franc, all goods and services purchased abroad automatically become cheaper.

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In his latest monetary policy statement, the SNB Chairman softened his stance: "our interventions on the foreign exchange market no longer focus primarily on selling currencies". Thomas Jordan emphasised that the nominal appreciation of the Swiss franc had played an essential role in keeping inflation under control, but that monetary conditions were now conducive to keeping inflation within the target range, below 2%. This change in rhetoric is significant. It suggests that, since December, the SNB has judged the rise in the Swiss franc to be exaggerated: not necessarily too strong, but too fast. It is therefore prepared to put the brakes on any further appreciation of the franc. The last two decades have shown that the Zurich-based institution's objective is not to prevent the franc from appreciating, but to slow it down, in order to give companies time to become more competitive and adapt.

Once again, after spending 18 months selling some 200 billion dollars and euros to reduce its balance sheet (and thus buy Swiss francs), the SNB has reversed course. According to our estimates, between 1st and 31 December 2023, the SNB bought the equivalent of CHF 11 billion. This is a significant amount, and we expect the SNB to continue to do so over the coming months (see Chart of the Week).

In 2023, the strength of the Swiss franc had a significant negative impact on Swiss exporters. Their products and services have become less competitive on international markets. Key sectors such as watchmaking, pharmaceuticals, and machinery, which are traditionally dependent on foreign markets, have found it difficult to maintain their market share in the face of competitors offering cheaper alternatives in local currencies. This situation has put pressure on the margins and profits of Swiss companies, particularly those of small and medium size. In 2024, Swiss companies will continue their efforts to adapt to this new "currency norm": optimising costs, relocating certain production activities, expanding into new markets, etc. If the SNB comes to their aid by curbing the appreciation of the franc, this will be all the easier for them.

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In the long term, exchange rates are mainly influenced by inflation differentials, i.e. purchasing power parity (PPP). The terms may sound complex, but they conceal a simple concept: the prices of goods and services must be the same everywhere on earth, otherwise currencies move to compensate. So, the higher inflation is in a country, the more its currency depreciates. And vice versa. Historically, with price growth lower in Switzerland than in the Eurozone or the United States, the franc has a natural tendency to appreciate. Exceptionally, under the effect of rising electricity prices (+18%), rents (+3%) and Value Added Tax (VAT from 7.7% to 8.1%), Swiss inflation will rise more rapidly in 2024. It could reach an annual rate of 2%. The gap between inflation in the Eurozone and the United States will therefore be very small. Unlike in recent years, this will not benefit the Swiss franc.

According to PPP, the franc is currently undervalued by -6% against the dollar. To be at its 'fair price', the greenback should not be trading at 0.86 franc but at just 0.81 franc (see Fig. 5). This type of anomaly is not uncommon, but it always resolves itself in the end. Similarly, the single currency could trade +10% above the current 0.94, i.e. against 1.04 francs (see Fig. 6). The franc is therefore overvalued.

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Conclusion :

Our econometric estimates, which take many fundamental parameters into account, anticipate (temporary) weakness in the franc against the euro (see Fig. 7). Investors are likely to rally to this type of analysis, knowing that it is in line with the SNB's comments on the franc's appreciation against the single currency: this time, it's too much!

Against the dollar, the outlook for the Swiss franc remains positive. The greenback has been supported by rising US yields, but this advantage is gradually being eroded.

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