The Japanese may have fired off the first salvo, persuading the balance of the G7 to support intervention to weaken the JPY following the Tōhoku earthquake back in March but it has been left to the Swiss to act with any real aggression in the so called ‘Currency Wars’ with a landmark step this morning, enacting a floor in EUR/CHF at 1.20 and offering unlimited amounts of CHF to defend this marker. The statement also pledged a readiness to adopt further measures should economic and deflationary risks warrant. Brave stuff.
Pressure had been building on the Swiss for some time. Clearly the franc is massively overvalued in both nominal and real terms and earlier - more orthodox - steps have proved ineffective. The minimum exchange rate option then is probably the only viable method of restraining the currency over the medium-term. There will of course be speculation about the resolve of authorities to defend this statement; Hildebrand came close to being forced out after earlier measures led the SNB to a US$21bn loss. But this policy is far more aggressive and the stakes immeasurably higher. More probable is that alternate safe havens should see a chunk of the otherwise Swiss destined flow (including gold and the high yielders).
Of course geography means targeting a rate vs. the EUR is the logical choice, though it also might reflect SNB expectations that the EUR itself is too rich – the statement noted that the SNB was aiming for a substantial and sustained weakening of the Swiss franc. Pegging oneself to a currency that ought to be cheaper could mean a return to more normalised levels of exchange is quicker that first appreciated. That said, the BIS suggest the CHF is 34% overvalued in NEER terms so normal still might not mean fair.
At this point we have reasonable confidence that the SNB policy will take some of the heat out of the CHF, even if this leaves the pair range trading above EUR/CHF1.20. In some respects it could even find itself a beneficiary of the carry trade, CHF being cheaper to short than EUR. It would be ironic if USD/CHF now became the route by which the market expresses its bearish EUR/USD ideas. Looking at the USD/CHF chart, a 0.9401/45 target does not look unreasonable with this in mind.
Looking at SNB resolve in the broader global context is equally interesting. We’ve already seen those free floating emerging currencies vex over hot money inflows, most vocally Brazil but also places like South Africa where the macro story is hardly compelling enough to warrant the level of exchange rate gains the country has seen. A peg or quasi peg might look alluring to such players.
Equally this type of policy might be right for the Japanese – even if the yen is nowhere near as overvalued as the likes of CHF, BRL or the antipodean currencies. More relevant for the Japanese is the policies of its direct competitors, most of which operate some form of dollar peg. As we’ve noted before, one only has to look at the market share grabbed by Korean corporates to realise the scale of the problem. Taking the moral high ground gets you nowhere in such instances. Free floating currencies are only viable in a world of freely floating currencies. A JPY currency floor would certainly focus minds on this type of anti-competitive behaviour, particularly at a time when the Fed and other central banks (UK specifically) are perceived to be mulling more quantitative easing (or similar) with the repercussions this ought to have for the dollar and its associates (CNY, KRW etc). PM Noda take note.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.