The Week Ahead: Just How Neutral is Switzerland?

Foreign Exchange: The Week Ahead
Just How Neutral is Switzerland?
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The U.S. Treasury last released its semi-annual FX report in January. Traditionally, these reports are published in April and October, so the calendar makes the Treasury’s FX report a relevant topic, despite the lack of guidance, back in January, on when the next publication would be released.

In the January report, no country was listed as a currency manipulator, but the monitoring list (meets 2 of 3 criteria) included China, Japan, Korea, Germany, Italy, Ireland, Singapore, Malaysia, Vietnam and Switzerland. Subsequent to this report, currency intervention data out of the Swiss National Bank (SNB) showed that the central bank purchased foreign currencies amounting to over 2% of GDP during the first half of 2020. This development suggests that Switzerland would now meet all three criteria for a currency manipulator.
 
While meeting all three criteria would provide justification for the U.S. Treasury to label Switzerland a manipulator, the U.S. Treasury should show leniency, as Switzerland is facing a unique situation. The COVID-19 crisis represents an extraordinary event, and puts enormous pressure on safe-haven assets such as the Swiss franc (CHF).
 
A stronger CHF puts downward pressure on inflation through lower import prices and a slowing domestic economy. This dynamic would justify monetary easy that can be done through quantitative easing (QE), interest rate cuts or FX intervention. QE is unattractive, as the local bond market is relatively small, and few large companies use capital markets in Switzerland to fund themselves. Interest rate cuts aren’t attractive, either, as rates are already deeply negative. This leaves FX intervention.

Due to these factors, the SNB should be able to make a persuasive argument that FX actions are due to domestic consideration, and not an effort to artificially weaken the currency. Further adding to Switzerland’s argument against currency manipulation is the country’s positive reaction to the U.S. Treasury’s push to use fiscal policy, with Switzerland injecting ~31 billion CHF worth of additional fiscal support. Finally, there are the political considerations. Switzerland is currently representing the U.S. in Iran, which should work in Switzerland’s favor.
 
Ultimately, the SNB isn’t trying to artificially weaken its currency. Rather, it is trying to avoid overly rapid currency strength. 

FORECASTS

EUR

The euro has been broadly range-bound this past month due to factors supporting USD weakness being offset by weakening European fundamentals. On the USD side, the greenback remains pressured by the expectation that a blue wave will lead to a pullback in trade tensions and massive fiscal stimulus after the election. On the European side, the health situation continues to deteriorate with COVID-19 cases increasing sharply and multiple countries reimposing lockdown measures that are health-positive, but growth-negative. Overall, the expectation is for the euro to range trade ahead of the U.S. election with U.S. polling data the key driver. Should Biden continue to lead, expect the euro to be supported. Conversely, should Biden’s lead narrow, USD buying should push EURUSD lower. Regarding rates, expect the ECB to hold rates unchanged.

GBP

The U.K.’s most recent Brexit deadline came and went without meaningful progress. Ultimately, talks are continuing, with the U.K.’s latest deadline proving to be just a negotiating tactic, as was widely expected. The new goal is now for a deal by mid-November, which is really the last feasible date for a deal on the current timeline. The lack of meaningful progress and Brexit history suggests both sides will push the envelope on negotiations and continue to express a willingness for a no-deal result until the last minute. As a result, the pound likely remains headline-driven, but negative headlines will likely be faded as markets assume the real progress historically only comes at the last minute. Domestically, the U.K. continues to underperform on COVID-19-related measures. This means more growth-negative lockdown measures are likely for an already weak economy. Should growth slow further, expect additional steps from the central bank that will pressure the pound.

JPY

The BoJ meets this week, and should be on hold. This leaves USDJPY to be driven more by overseas factors than domestic ones. Rising uncertainty/COVID-19 cases have provided support to the yen, and a pullback in outbound investment flows, relative to the pace set at the beginning of the year, has neutralized what was an idiosyncratic source of yen weakness and, all else equal, biases the yen toward strength. Regarding the U.S. elections, market pricing firmly implies a smooth Biden victory. While the polling gap between Biden and Trump is wider than the gap between Clinton and Trump in 2016, that 2016 gap narrowed sharply in the final weeks of the campaign. The problem with a strong consensus position is the high vulnerability to swings in sentiment, as there is more room for risk-off than risk-on. This supports being long safe-haven currencies, such as the yen, on the possibility that polling could narrow, especially in swing states.

CAD

The Bank of Canada (BoC) announced that it is scaling back three liquidity programs due to a decline in usage. This signals a shift in the BoC’s policy mix from emergency measures to a more accommodative stance supported by low rates, QE and forward guidance. The BoC holds its next meeting this week, and should hold steady. Beyond monetary policy, COVID-19 cases continue to rise, but Canada’s positivity rate remains below that seen in its first wave, and in other advanced economies such as the U.S. and UK. The expectation remains for the loonie to be driven by the global risk backdrop and broad U.S. dollar moves.

CNY

After weeks of yuan appreciation, Chinese officials have taken some measures to signal their concern about the yuan's advance, although these measures are relatively symbolic in the overall picture. Near-term, the U.S. elections are important, given the significant trade policy differences between Biden and Trump. Both are expected to pressure China, but Biden should rely less on tariffs, which should reduce trade uncertainty in China and around the world. Beyond the U.S. elections, China’s strong balance of payment position, relatively high interest rates and outperformance on COVID-19 infection rates supports further appreciation.

AUD

The Reserve Bank of Australia (RBA) minutes continued the dovish narrative out of the central bank. In the minutes, the central bank “agreed to maintain highly accommodative policy settings as long as required, and to continue to consider how additional monetary easing could support jobs as the economy opens up further.” Beyond monetary policy, Australia-China tensions continue to weigh on exports and overall market sentiment, and suppress additional investments such as mining companies pursuing capex to take advantage of high iron ore prices. Overall, a more dovish RBA and risks to exports from Australia-China tensions should both weigh on the AUD with the risk for consolidation due to its ~4% drop since early September.

MAJOR CENTRAL BANK ACTIVITY THIS WEEK

10/28 Canada Expectations for rates to remain unchanged at  0.25%
10/28 Japan Expectations for rates to remain unchanged at -0.10%
10/29 ECB Expectations for rates to remain unchanged at -0.50%

KEY MARKET MOVING ECONOMIC RELEASES

United States and Canada

10/29 U.S. Initial Jobless Claims Expectations for 785K claims
10/29 U.S. GDP QoQ Expectations for a 31.9% annualized increase
10/30 U.S. Personal Income Expectations for a 0.3% increase
10/30 Canadian GDP MoM Expectations for a 0.7% increase

Europe/Eurozone 

10/30 EZ GDP QoQ Expectations for a 9.5% increase
10/30 EZ Unemployment Rate Expectations for a 0.1% increase to 8.2%
10/26 German IFO Business Climate, Expectations and Current Assessment Survey Expectations for a 93.0, 96.3 and 89.7 print, respectively

Asia/Japan, and New Zealand 

10/30 Chinese Manufacturing and Non-manufacturing PMI Expectations for a 51.5 and 56.1 print, respectively
10/29 Japanese Industrial Production MoM Expectations for a 3.0% increase
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