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Zero francs given

Here are spot returns against the dollar across G10 currencies since last Thursday:

Imagining you hadn’t read the news since then, which one of these countries would you say had a banking crisis so severe that authorities shanghaied its two top lenders into an emergency merger?

The Swiss franc has long has a reputation — usually alongside the Japanese yen — as being one of the world’s “safe haven” currencies. That reputation is looking thoroughly deserved at present.

Barclays’ Lefteris Farmakis took a look at the Swissy on Wednesday, assessing if its safety chops have been shed post-Credit Suissxit. The answer? Absolutely not.

From his note (login walled) on the topic:

By ‘safe assets’ one typically has in mind default-free government bonds which are in considerable international demand. In this sense, Switzerland is already an exception in light of its very small stock of government debt and international ownership. Instead, the ‘safe asset’ that Switzerland exports to the world is Swiss franc denominated deposits . ..

This way of broaching the issue sheds light on another feature of these economies, namely a persistent positive yield differential between external assets and liabilities. If a country exports low yielding (because low risk premium) ‘safe assets’ but invests in riskier ones, it is no wonder that it sustains a positive yield differential for a long time.

The timing of this crisis was admittedly decent for the franc, which has been strengthened as the Swiss National Bank uses rate hikes and forex sales to prop it up and combat inflation.

Swiss rate-setters shrugged off the parley on Paradeplatz to press ahead with hiking, increasing its policy rate 50 bps to 1.5 per cent at a meeting yesterday.

Writing in the wake of that decision, Kit Juckes from Société Générale was also upbeat on the franc (our emphasis):

The Swiss National Bank has long realised that free flow of capital and a stable exchange rate aren’t compatible in an economy with a bulletproof current account surplus, and a dual mandate to promote financial stability and low inflation. They’ve being mopping up capital inflows and managing the exchange rate for years and have no qualms about offsetting capital outflows if currency stability demands it. Today’s decision to raise rates by 50bp, coming hot on the heels of a move to stabilise the Swiss banking system, however, tells us that inflation-fighting remains a central concern. The SNB really doesn’t like inflation.

The speed with which the Swiss banking system was stabilised (regardless of the fallout over CoCos) reinforces the franc’s safe-haven status. That suits the SNB now, more than usual.

All well and good — the world’s favourite neutral (neutral evil?) country is totally free from currency-classification calamity, but it looks pretty snug. Lefteris:

This way of framing the issue sheds light to the fundamental changes in the country’s balance sheet that are required for franc de-classification as a ‘safe haven’.

Accordingly, the share of Swiss-issued ‘safe assets’ in external liabilities needs to drop via large and sustained outflows. This would lead to an increase in domestic interest rates, thereby increasing the yield Switzerland’s external liabilities pay and further weighing on the country’s yield differential (over and above the largely temporary effect of the post GFC-macro environment)…

In such a scenario, the SNB would likely attempt to smooth out the transition by cushioning capital outflows along with their impact on the franc. But there are limits to this. This is because Switzerland’s FX reserves are only a fraction of its liquid liabilities.

He concludes:

In all, the de-classification of the Swiss franc from ‘safe-haven’ status requires radical shifts in the structure of Switzerland’s balance sheet via sizeable ‘safe asset’ outflows. This is very unlikely to materialise in the near term on the back of the Swiss banking sector turmoil, and it is also debatable whether this shift may unfold over the longer term.

So, all good for the little franc that could, for now. Rivellas all round?

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