I’m ending this year’s series of year-end currency reviews with the Swissy, and for good reason.
Unlike the clear-cut (more or less) price action on the other currencies, price action on the Swissy was rather … chaotic, with plenty of diverging price action, so much so that I wouldn’t blame you if you had the exact same reaction to the chart as the image below.
On a more serious note, the messy price action on the Swissy indicates that drivers for the opposing currencies were, well, driving price action on the various Swissy pairs.
Still, the Swiss franc had more losses, scoring wins only against the euro and the pound, the two currencies that got the brunt of the major events this year. And the Swissy’s rather uninspiring performance this year was likely due to two factors:
- The search for higher returns
- The sneaky SNB’s shenanigans
The Search for Higher Returns
There were plenty of risk events in 2016, as you may have gleaned from my Monthly Review of 2016’s Trading Themes. So why are the major equity indices (other than Chinese equity indices) in the green year-to-date, as of December 29, 2016?
- The DOW (DJI) is up by 13.82% to 19,833.68 for the year
- S&P 500 (SPX) is up by 10.08% to 2,249.92 for the year
- The Euro Stoxx 50 (STOXX50E) is up by 0.15% to 3,273.50 for the year
- The FTSE 100 (FTSE) is up by 13.73% to 7,099.90 for the year
- The DAX (GDAXI) is up by 6.46% to 11,442.50 for the year
- Nikkei 225 (N225) is up by 0.59% to 19,145.14 for the year
Sure, risk sentiment did improve by a lot after Trump won in November. And there were also other, more particular factors, such as demand for export-oriented British companies after the pound plunged in the wake of the pro-Brexit vote. Still, the question remains. What drove equity indices to be broadly higher this year despite risk events aplenty?
Well, that’s actually a rather pointless question because the heading already gave away the answer. Also, you may already have an idea about it, since I mentioned it in passing in my year-end reviews for the Aussie and the Kiwi.
Anyhow, the search for higher returns in a low-yield, low-growth world is also one of the major themes driving the global markets this year, at least before the Trump Effect came into play in November.
The gist of it is that the QE programs of the major central banks mainly target government bonds for their asset purchase programs, which drive up bond prices. And as you have learned from our School’s lesson on How Bond Yields Affect Currency Movements, bond yields and bond prices are inversely correlated, so higher bond prices means lower bond yields, which then means that bonds are no longer very attractive as investments.
This forces hedge funds and other big players to search for higher returns elsewhere. Some go to higher-yielding bonds from developing countries. Some go to higher-yielding currencies, such as the Kiwi or the Aussie. And others go to equities, despite their relatively riskier investment profile.
Demand for equities in a low-yield world, in particular, is something that Goldman Sachs mentioned in its 2016 outlook. And an article from The Economist points to search for higher returns as one the drivers for the broad-based equities rally before the Trump Effect came into effect in November. There’s even a cute article for individual investors from Forbes titled How To Invest For Income In A Low-Yield World and it’s basically all about stock-picking.
Anyhow, the search for higher returns also means lower demand for the lower-yielding Swiss franc. But wait, shouldn’t price action on the Swissy and the yen be similar, given that both are safe-havens and there were plenty of risk events before risk sentiment improved post-Trump? So why was price action on the Swissy more chaotic and subdued compared to the yen?
Well, there’s ….
The Sneaky SNB’s Shenanigans
If you can no longer remember, the SNB was forced to remove the 1.2000 floor on EUR/CHF last year, which caused the Swissy to appreciate tremendously across the board. And because of that appreciation, SNB officials have been threatening in every SNB monetary policy assessment, including the most recent one, that they’ll “remain active in the foreign exchange market as necessary” because the Swissy is “still significantly overvalued,” so currency manipulation, er, I meant to say “being active in the forex market” is “intended to make Swiss franc investments less attractive, thereby easing pressure on the currency.”
And SNB officials really do make good on their threat of intervention. And you can see this when you look at the sight deposits with the SNB, as well as the SNB’s foreign currency investments.
Let’s take a look at the sight deposits first. Oh, for those who don’t know sight deposits are a given bank’s most liquid assets that are deposited in the SNB, which are then entered into the SNB’s own books as liabilities. Domestic Swiss banks, in particular, have sight deposits to meet their minimum reserve requirements. And these sight deposits that are just parking there in the SNB are used to finance currency manipulation operations. Oops! I said it again. I meant to say “being active in the forex market.”
Anyway, rising sight deposits therefore imply that the SNB is “being active in the forex market” and as you can see on the table below, the SNB has been very active in the forex market all year.
Note, in particular, the relatively large increases in June and November. The large rise in November was very likely a response to higher safe-haven demand because of uncertainty related to the U.S. elections while the very large increase in June was very definitely due to Brexit. And I’m 100% sure that it was due to Brexit because the SNB blatantly admitted that it intervened, saying the following in an email published by Bloomberg.
“Following the United Kingdom’s vote to leave the European Union, the Swiss franc came under upward pressure … The Swiss National Bank has intervened in the foreign exchange market to stabilize the situation and will remain active in that market.”
As for the SNB’s main targets when it’s “being active in the forex market,” below is a table showing how the SNB has been hoarding foreign currencies.
As you can see, the SNB primarily targets the euro, which accounts for around 43% of total foreign currency purchases as of Q3. This makes sense, given that the lion’s share of Switzerland’s exports make their way to the Euro Zone (Germany mainly), with exports to the Euro Zone accounting for CHF 8,324 million (44.3%) of Switzerland’s CHF 18,787 million worth of exports in November.
The second biggest target for “being active in the forex market” is the Greenback, which accounts for 33.3% of total foreign currency investments. This also makes sense, since the U.S. is the second biggest market for Swiss exports, accounting for about CHF 2,768 million (14.7%).
Also note, that SNB’s foreign currency investments have been ballooning, which goes to show that they are trying really hard to weaken to Swiss franc. Although the SNB did lighten up a bit on their yen holdings by the end of Q3, which is a really smart move, given how rapidly the yen depreciated in the wake of Trump’s victory in November.
And the SNB’s efforts do appear to be somewhat effective, given how the Swissy performed this year. And while the Swissy did manage to win out against the euro, pushing EUR/CHF lower for the year, EUR/CHF happens to have the smallest loss among the major euro pairs, so the SNB’s efforts do seem to have an effect.
What do you think? Will the sneaky SNB continue with its shenanigans next year? Share your thoughts by voting in the poll below!