JPY and CHF and the intervention policy - Rabobank

Jane Foley, Research Analyst at Rabobank, notes that just hours after the results of the UK’s EU membership referendum were published on June 24, the SNB confirmed that it had intervened in the FX market.

Key Quotes

“The statement clarified that “following the UK’s vote to leave the EU, the CHF came under upward pressure. The SNB has intervened in the FX market to stabilise the situation and will remain active in the market”. Although intervention is a key instrument in the SNB’s toolbox, it is not common for a statement to be issued. That said, confirmation of intervention was similarly published last June following Greece’s announcement of a referendum on its bailout terms. Shortly after this ripple from Greece, came the shock of China’s stock market crash. Interestingly, the CHF did not perform well as a safe haven currency in this period. It seems that the SNB’s policy of negative rates and intervention has had the effect of making the JPY, the safe haven of choice.

When the SNB abruptly ceased protecting the EUR/CHF1.20 floor in January 2015, the market’s understanding of the SNB’s intervention policy was initially thrown into disarray. Although balance sheet pressures have discouraged the SNB from specifying another exchange rate floor, it soon became clear that intervention remains an important part of the central bank’s aim of diverting inflows from the CHF. In terms of fundamentals, the CHF is arguably the most attractive safe haven currency.

In an ideal world a safe haven currency would be associated with both a current account and budget surplus. There would be strong levels of liquidity, a coherence central bank and high levels of trust and stability in government and legal systems. Arguably the CHF comes closest to ticking all the boxes. This creates significant problems for the SNB since safe haven flow means that interest rate differentials may have little sway on CHF cross rates for lengthy period of time.

Despite the SNB’s very aggressive policy stance, on almost every measure the CHF is overvalued. This factor coupled with the relatively small size of the Swiss economy are likely two reasons why the SNB does not suffer heavy international criticism for intervening in support of its currency. It could be argued that the SNB’s purchases of EUR push back against the ECB’s efforts to stimulate the Eurozone economy. That Swiss, however, could counter with the argument that if the EZ had remained crisis free and was growing at a firmer pace, there would have been far less demand for a safe haven currency in recent years.

The SNB’s lacklustre performance relative to the JPY over the past year or so may in part be a function of heavy short covering of EUR shorts through much of last year. This lent safe haven characteristics to the EUR. That said, we would argue that the pressure on the Japanese authorities not to intervene is a significant reason why the JPY has trended higher vs. the CHF. As a G7 member Japan has frequently signed communiques agreeing that market forces should set exchange rate values. In this context intervention by the MoF would be heavily frowned by other G7 nations upon, particularly by the US Treasury.

Due to low levels of inflation, no developed country would currently welcome a stronger exchange rate. Intervention by the Japan could be seen as a measure to export its disinflation pressures overseas.

Despite a few threats the Japanese authorities have not intervened in the FX market since the 2011 tsunami and nuclear disaster. Talk that BoJ policy is reaching the end of the line has added to JPY support this year. We see scope for further downside in CHF/JPY in the coming months.”