THE SWISS FRANC SEEMS UNSHAKABLE

ANALYSIS OF THE FOREIGN EXCHANGE MARKET

Since 2007 and in a fairly linear fashion, the Swiss franc has appreciated by +3.6% per year against its main counterparts. In 2023, it made an additional gain of +1.8%, rising by +3.5% against the US dollar and +0.9% versus the euro. Of the 17 major currencies traded around the world, only the Mexican peso and the Brazilian real managed to perform better (see Fig. 2). How was such a success possible this year, in an environment where the Swiss National Bank (SNB) only marginally raised interest rates, making holding Swiss francs comparatively unattractive (see Fig. 3), and where the country's second largest bank (Credit Suisse) had to be bought out by the largest (UBS) in March to avoid a banking crisis?

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On the evening of Sunday 19 March, in order to stop the fears of investors and savers, the Swiss National Bank (SNB) supported the takeover of Credit Suisse by its great rival UBS by allocating aid in the form of liquidity. Despite these large credit lines, which could reach CHF 200 billion if necessary, the central bank's balance sheet managed to remain relatively stable in March.

Within this balance sheet and adjusting for exchange rate and asset valuation effects, foreign currency reserves were reduced by -31 billion. This is in addition to the -100 billion of the previous 9 months (see Fig. 4).

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By buying Swiss francs (i.e. selling dollars and euros), the SNB is killing two birds with one stone:

• It erased a large part of the money that had been printed during the Covid-19 pandemic (see Fig. 4). This contraction of its balance sheet thus allows it to rebalance (tighten) its monetary policy.
• By reducing the supply of Swiss francs, it promotes the appreciation of the national currency and, as a result, contains inflationary pressures. All goods and services that companies buy abroad automatically become cheaper.

According to the Purchasing Power Parity (PPP) approach, the franc is currently undervalued by -9% against the dollar. To be at its "fair price", the greenback should not be exchanged against 0.90 franc but only against 0.82 franc (see Fig. 5). This type of anomaly is common, but it always ends up being resolved.

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Recently, it was justified by the yield differential between two-year bonds (see Fig. 6). Taking this parameter alone, it was possible to justify a dollar at parity against the franc. With the yield differential set to narrow as the SNB's monetary policy tightens towards that of the Fed or as the Fed "pivots", the franc is likely to continue to appreciate. The situation of the franc may look different against the euro. Still, according to the PPP, the single currency could be exchanged for 1.05 francs, i.e. +7% above the current 0.98 (see Fig. 7). The franc is therefore overvalued. In reality, given the inflation differential between the two areas (see Fig. 8), investors are simply anticipating 18 to 24 months of persistently lower inflation in Switzerland. By then, the equilibrium exchange rate will also have fallen below parity.

Our econometric models are based on these explanatory factors, among others. They are imperfect insofar as they do not reflect variations linked to short-term parameters, nor the emotional behaviour of investors. However, the forecasts they generate are sufficiently reliable from a trend perspective (see Chart of the Week) and the message is clear: the franc will become increasingly strong.

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Conclusion

The fundamentals of the Swiss franc are excellent. The Swiss currency appreciates in times of economic growth, and even further when economic and financial risks increase. Low bond yields are not deterring investors. They will now have learned that the exchange rate of the franc can also improve when the Swiss financial system is subject to an emergency rescue. Econometric models expect the trend to strengthen. Over the next 20 months, the Swiss franc will appreciate against the euro and much more versus the dollar.

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RETURN ON FINANCIAL ASSETS