CHF The SNB’s FX resolve soon to be tested

CHF The SNB’s FX resolve soon to be tested

 The resignation of SNB Chairperson Hildebrand does
nothing to change our fundamental view of the SNB’s
currency peg – the policy will not be abandoned just
because its chief architect is no longer setting policy.
That being said, it will be easier for Hildebrand’s
successor to contemplate an eventual relaxation and
removal of the peg once the costs of artificial currency
weakness (loss of domestic monetary stability) outweigh
the costs, which in our opinion will occur in late 2012
/into 2013. A decision on the new SNB Chairperson
could still be a few months away. The SNB’s Bank
Council (its supervisory body) first has to nominate a
replacement for Hildebrand on the three-person
Governing Board. The government (the Federal Council)
will then appoint this individual and select the
Chairperson from the three board members. Thomas
Jordan is currently serving as the interim Chairperson but
is also a strong candidate for the permanent post.

 Unexpected though the drama at the SNB was, the Swiss
franc is performing much as we had anticipated, with
EUR/CHF slowly gravitating towards the 1.20 floor. In
announcing a floor for EUR/CHF, the SNB did nothing
to abolish the almost embarrassingly positive
fundamentals underlying the franc (the current account
surplus inconveniently rose to a new record high of early
16% of GDP in Q3). The floor is a policy target, not a
separate policy tool, and in order to maintain the floor the
SNB must neutralize this excess flow demand for the
currency, either through its own actions (increasing the
supply of francs) or by encouraging countervailing
private sector selling of the currency.

 The SNB succeeded in weakening CHF through Q4
through a combination of 1) massive liquidity injections;
and 2) encouraging short-term speculative sales of the
currency by suggesting that the 1.20 floor in EUR/CHF
could be raised. Once, however, the SNB failed to raise
the floor at its December meeting, short-term players
started to cover their short CHF positions. In addition,
the SNB has been quietly but persistently removing
excess liquidity from (sight deposits have fallen by
nearly CHF 40bn or 15% from their peak). This may
seem curious, given that a reduction in CHF liquidity
should naturally tend to strengthen CHF, but in our
opinion the SNB’s liquidity management merely
confirms that the SNB is bluffing when it claims it will
do whatever it takes to weaken the franc. The only way
the SNB can permanently weaken the currency is by
sacrificing domestic monetary stability (currency
weakness requires massive monetary expansion which
will ultimately threaten inflation, ever higher real estate
prices and greater risks to financial stability). The SNB
has the ability to weaken the currency should it so
choose; on this we are very clear. But we are equally
clear that the currency peg is not a costless policy and
that ultimately the SNB will not be willing to sacrifice
internal stability for the sake of external stability.

 The SNB thus funds itself at a difficult juncture. We do
not believe the peg will be scarified in the next 3-
6months but the SNB will either need to loosen liquidity
again through FX swaps or start to intervene in spot if it
is to hold the line at 1.20. The current constellation of a
record current account surplus, record low EUR-CHF
interest rate differentials and tighter liquidity conditions
is not consistent with FX stability.

JP Morgan Forecasts CHF

CHF Potential trigger events

 Despite the unprecedented intervention of the SNB by
putting in a floor at 1.2000, the market did exactly what a
4th wave recovery on bigger scale would do, which
means forming a classical zigzag pattern up with a high
likelihood of stalling at one of the 2 projected targets at
1.2478 and at 1.2650. Having done so, the real stress test
for the SNB in terms of counteracting market forces, is
still lying ahead of us. Following this Elliott-count, the
missing 5th wave decline, which should at least come
close to the 1.0068 bottom, should already be on its way,
but for a confirmed break it would of course take breaks
below 1.2000 and a former pivotal top at 1.1974. The
picture in USD/CHF is slightly more positive as the
bounce from 0.7064 (August 2011 low) to the last top at
0.9597 shows a 5-wave pattern up, which implies that
any setback would only be a countertrend decline
(maximum down-risk to 0.7662 = 76.4 %) in a broader
up-consolidation or in a new up-trend.

 In the short-term picture of EUR/CHF we are now
keeping a close eye on key-resistance at 1.2189 (minor
38.2 %) as a break above the latter would call for a
minimum rally to 1.2355 (minor 76.4 %) if not for an
extension towards the key-resistance barrier at 1.2650
(38.2 % on higher scale). Particularly below 1.2103
(hourly Ichimoku-lagging) though, the latest downrotation
remains intact and key-support at 1.2000/1.1974
in focus. An additional buy-signal for CHF would be
given via a break below 0.9243 (last low) in USD/CHF.