Why I'm Bearish on the Swiss Franc

Includes: EWL, FXF
by: DayOnBay

By: David Veitch

What to expect in the months ahead for this enigmatic currency.

On March 1, when asked by Squawk on the Street if he had to shift all of his US Dollar assets into another currency, Warren Buffett responded that he would pick the Swiss Franc. The world’s greatest stock-picker turned out to be a prescient forex forecaster. At March 1, USD/CHF sat at 1.079; the Swiss Franc has since appreciated, bringing USD/CHF to 0.98.


The Swiss Franc has always held a unique place within the forex market. USD/CHF is considered one of the “major” currency pairs. This is true despite the fact that the Swiss economy is relatively small compared to the world economy, with only eight-million inhabitants and a GDP of $500 billion. The Swiss Franc has also been known historically as a safe-haven currency; this led it to benefit during the darkest days of the financial crisis.

While Warren Buffett may have proven his currency forecasting mettle in the short-term, it is likely that in the coming months this ability will be put into question. The Swiss Franc, while having benefitted from the unique events of the past two years, is likely to weaken in the months ahead. In arriving upon this conclusion, one can look to recent central bank developments, as well as the franc’s status as a reserve currency.

Recent Developments

High on investors’ minds after the Swiss National Bank’s (SNB) Monetary Policy Assessment of September 16 is the prospect of a further weakening from the Swiss Franc. The SNB kept its target LIBOR rate unchanged at .25%, citing a lowered inflation forecast as the key reason. However, the decision to keep the rate at .25% was not what moved the markets. Rather, it was the dovish tone of the statement that led market participants to revise their interest rate expectations, as many were expecting a possible rate hike before the end of the year.

This statement came against the backdrop of Switzerland’s healthy growth, which was helped by the fact that it does not face the same high debt levels that other developed countries do. Swiss growth has benefitted from a strong rebound in exports and imports from 2009. Swiss exports are generally high-end goods including pharmaceuticals, watches, and precision instruments; combined, these three categories make up roughly 50% of exports. While on one hand many of these exports are price inelastic (i.e. demand is not affected that much by changes in price), a strong franc has not been conducive to higher Swiss exports, and hence growth. Going forward, exports could be particularly affected by a slowdown in growth from the Eurozone as a result of austerity measures in various peripheral countries affecting the Eurozone.

The Risk of Swiss Deflation


What will guide the SNB, and hence the direction of the CHF in the currency markets, are developments regarding the Swiss inflation picture. The Swiss National Bank caused a stir when it lowered its inflation forecasts by almost 1% for 2011 and 2012. Inflation is expected to remain positive throughout 2011, but only barely. Given the SNB’s statutory mandate of ensuring price stability (the SNB considers prices stable when CPI is growing at 2%) they may be forced to act in the medium term.

The risk of deflation is evident when examining key metrics of the Swiss economy. For one, the Swiss output gap (the difference between actual and potential GDP) remains negative at roughly -0.5%. This gap has been narrowing as of late; however, narrowing or not, a negative output gap suggests that deflation may be in the cards, which could force the SNB to act. On a similar note, capacity utilization in the Swiss economy, while improving, remains below potential. The gap is especially apparent in the chemical industry, and some areas of the watch-making industry.

The primary driver of deflation risk is the strong Swiss Franc. The strong franc has held down import prices, in particular those of commodities. Lower commodity prices have rippled through the economy, affecting the prices of energy and intermediate goods.


Also, a strong franc has negatively affected capacity utilization in exporting industries as they have faced lower demands for their products. This is especially damaging for Switzerland who, in comparison to many other European countries, derives a high proportion of its GDP from exports. Although, it should be repeated that since many of Switzerland’s exports are high value added products they are less sensitive to price swings, and only some firms have been affected by the franc’s strength.

But will the central bank act? The SNB last intervened in the currency markets in June to help weaken the rapidly appreciating franc, yet it ultimately did little to stem its rise. Given the current furor over countries devaluing their currencies, it is unlikely that the Swiss would do the same, considering their economy is in relatively better shape than the rest of the world. The SNB chief has left the door open for this however. It is more likely the SNB will use alternate tactics to bring its value down, such as keeping rates on hold and adjusting the market’s expectations of inflation (as they did on September 16). This should act to help soften the currency and be positive for both inflation and growth.

Looking at the Franc as a Reserve Currency

Economic fundamentals aside, it is also crucial to examine the franc’s role as a reserve currency to ascertain its future trajectory. The franc’s performance over the course of the crisis has been closely tied to the market’s risk appetite. However, as the future economic picture becomes clearer, investors will likely realize that the currency of a country with a population of eight million makes a poor reserve currency. Also, as restrictions on the Chinese yuan become relaxed, investors will shift assets out of the franc and into the yuan.

In terms of positioning, the EUR/CHF and JPY/CHF crosses present two separate dilemmas. Despite its recent run-up, the euro is subject to a number of considerable risks. And, considering the lack of impact that a recent run-up in Greek and Irish CDSs had upon the euro, there is a lurking possibility that the market may respond sharply to a quick deterioration in the situation. In terms of the yen, the prospect of another intervention by the Bank of Japan still exists, and it is likely Japan will continue to throw whatever resources it can at addressing deflation and in turn weaken the yen.

Instead, the CHF/GBP and the CHF/CAD are currency pairs which are to be sold shot. This attraction comes largely from what they are not, the euro/dollar/yen. They remain attractive crosses for they do not carry as much risk as some of the other major currencies, which, for fundamental factors, could experience steep devaluations in the months ahead.


Further Reading:

  • The Economist - Country Report Switzerland – October 2010
  • Nomura Global FX Weekly, October 21
  • SNB Q3 Quarterly Bulletin

Disclosure: No positions