2010 Currency Outlook: CHF

The SNB was one of the most aggressive central banks in implementing loose monetary policies to fight against the recent recession. Between October 2008 and March 2009, the SNB has reduced the 3-month LIBOR target rate by 250 bps to 0.25%. In March, the central bank also announced a series of liquidity provision programs including additional repo operations and purchases of Swiss franc bonds issued by private sector borrowers. The central bank also declared to purchase foreign currency on the foreign exchange market so as to prevent any further appreciation of the Swiss franc against the euro.

Economic outlook has shown improvements after several months' of ultra expansionary measures. The SNB then took a first step in exiting from these policies by announcing an end to the purchases of Swiss franc private sector bonds in December. At the same time, the SNB seemed to have worked less hard to intervene appreciation of Swiss Franc although it has retained the statement that 'the SNB will act decisively to prevent any excessive appreciation of the Swiss franc against the euro'. On December 18, The Swiss franc strengthened beyond 1.50 per euro for the first time since March. When asked, the SNB Spokesman declined to comment and EURCHF continued to decline. This apparently suggested the central bank does not care about it as much as before.

We believe the SNB has not given up intervention. Rather, it's the central bank's tactic that it tries to increase the uncertainty about the timing and level of intervention. Since March's meeting, it seemed to be a general perception that the SNB would intervene if EURCHF fell below 1.5. Effectiveness of currency intervention will be damped if it's well-predicted by the market.

In fact, the Swiss Franc did not weaken much last year despite the SNB's verbal or actual intervention. Against the dollar and the euro, the franc rose +3% and +0.2% respectively. Trade-weighted CHF remained in record high.

In 2010, the Swiss franc should weaken against the dollar and the euro. Economic recovery in Switzerland remains too fragile for an exit from the ease monetary policy. We believe the SNB will keep interest rates at current low level at least until 4Q10. The central bank will reiterate to 'act decisively to prevent any excessive appreciation of the Swiss franc against the euro'.

Economic Outlook: Switzerland's economy exited recession in 3Q09. GDP grew +0.3% qoq in the third quarter after contracting since 3Q08. Other indicators such as Ifo and KOF were also encouraging and signaled further improvement in 2010. However, the pace of recovery may not be as fast as the market has anticipated. SVME PMI rose to 56 in January but the reading surprisingly dropped to 53.7 in the prior month. KOF leading indicator has kept going upward after hitting a bottom at -1.8 in April, 2009. However, the rise has moderated in recent months.

Inflation has been one of key gauges in determining SNB's monetary policy. At previous meetings, the SNB stated therefore it's inappropriate to raise interest rates as risk of deflation remains. In December, the country's CPI fell -0.2% from November but rose +0.3% on annual basis. Petroleum price plunged -2.4% during the month and was the major contributor to the disappointment. On annual basis, petroleum price surged +3.4% as December 2008 and January 2009 were the trough for oil prices. Inflation in Switzerland has undershot market expectations in 5 out of the last 6 months. The central bank forecasts average annual inflation will amount to approximately -0.5% in 2009, +0.5% in 2010 and +0.9% in 2011. Switzerland's inflation is not expected to reach SNB's target of 2% in coming few years.

Although economy has been recovering, we hesitate to say the country is out of woods as domestic demand remains weak and currency appreciation continues to suppress price level.

Increase in retail sales (excluding fuel) narrowed to +0.6 yoy in November from +4.6% in the previous month. Despite the volatile nature of the barometer, the general trend suggested retail sales remain sluggish. Moreover, the reading indicated the dismal job market remains weighing on household spending. Unemployment rate rose to 4.45, the highest level in 11 years, in December.

Currency Intervention: In order to fight against lingering deflationary risks, the SNB President Philipp Hildebrand reiterated in January that the central bank will 'resolutely prevent an excessive appreciation as long as there are deflationary risks'. At the same time, the central bank believed it's in appropriate to raise interest rate at this time.

The SNB's intervention policy can be dated back to March 2009 when the central bank, together with bringing down the 3-month LIBOR target to as low as 0.25%, decided to increase liquidity substantially by engaging in additional repo operations, buying Swiss franc bonds issued by private sector borrowers and purchasing foreign currency on the foreign exchange markets. Since then, the EURCHF has rarely traded below 1.5, although the SNB stressed there's no 'fixed threshold' for currency intervention.

However, the Swiss franc, on December 18, strengthened beyond 1.50 per euro for the first time since March but the SNB did not react. Since then, the decline in EURCHF has accelerated on speculations that the SNB has turned more relaxed on CHF's appreciation.

There are probably 2 reasons for SNB's lack of activity. Policymakers do not want the market to predict the timing and level of their intervention as it may dampen the effectiveness of intervention. Moreover, the risk of deflation seemed to have eased since July 2009. Therefore, the SNB might have considered unwinding some of its non-standard measures. However, we do not expect the SNB will give up intervention and let CHF rise freely as economic recovery remains fragile.

Currently trading around 1.48, EURCHF remains well-below 5-year average of 1.57. It's likely that the SNB will take action anytime to bring the franc to a lower level.

In the face of recent heavy selloff of the euro upon deteriorating fiscal condition in Greece, we are considering to lower our forecast on the euro, which will hence reduce corresponding euro crosses including EURCHF. We will be closely monitoring the likeliness of a bailout and possibility of a spread to other European economies. News on credit rating agencies and market pricing of CDS on sovereign debts are also important issues to follow.

2010 Forecast Table - CHF