RBC’s FX strategy team think the SNB might go as far as buying Spanish and Italian debt, in a bid to find a return for its intervention-related euro cashpile:

There is a new 1.20 floor in EUR/CHF. The SNB announced it early on Tuesday – sending EUR/CHF up 10 big figures, from its 1.1020 Asian low to 1.2020 now. The move in EUR/CHF triggered risk on across the board (erasing earlier losses in risk proxies – sending EUR/USD, USD/JPY and all risky FX higher) but we do not think that move will last. We used the spike in USD/JPY spot to set up a put spread trade. We still think the BoJ/MoF intervention aims will still be more moderate.

Turning to CHF, in a short press statement, the SNB announced “With immediate effect it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF1.20. The SNB will enforce the minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.” The question immediately turns to whether this floor is credible. After all the last time the SNB attempted intervention (2009-2010) it was hardly a long-term success.

There are two key differences now: (1) what got in the way last time was the SNB’s eventual need for tighter policy which was incompatible with a ceiling for its currency. By contrast now, central banks around the world are on hold or loosening and with a renewed risk of Swiss deflation (CPI printed at 0.2%y/y today, cons 0.3%), loose policy is not an obstacle.

(2) defending 1.20 in EUR/CHF is a lot easier than defending 1.50. Most estimates of fair value lie somewhere between the two. So last time the SNB was defending a floor that almost unavoidably had to give way at some point – this time the SNB has a floor where in its own words “the Swiss Franc is still high”.

That is not an unreasonable claim to make. There are plenty of good reasons for CHF to remain high – the general risk-averse environment, Eurozone troubles, the lack of evidence of CHF strength impacting exports. And there is no doubt the market will test the SNB’s resolve, forcing it to sell sizeable amounts of CHF. But if the SNB is committed to this floor (and as noted above, it has fewer obstacles in its way than it did in 2009-10), it should be able to maintain this level as a minimum, until risk appetite improves.

If the SNB dares let it slip, it would mean a huge loss of credibility and that should be reason enough to sell whatever it takes. That means EUR/CHF vols lower as the cross gets trapped into a narrow range. Also note the SNB says “if the economic outlook and deflationary risks so require, the SNB will take further measures” which implicitly leaves open the possibility of further raising the floor. What does the SNB buy? At end-Q2, reserves were held 55% in EUR, 25% in USD, 10% in JPY, 4% in CAD, 3% in GBP and 3% in other. Of that, the majority was in AAA bonds. We do not want to make suggestions on what the SNB should buy but if it really wants to support EUR/CHF, buying Italian and Spanish debt might not be such a bad idea.

Nomura’s Peter Attard Monalto looks at the impact on CHF-exposed CEE countries, including the Hungarian forint and the likely moves from the country’s central bank:

The question of if the MNB MPC can cut on aggressive SNB CHF action has been going around for the last month or so. We said then they wouldn’t cut and we say the same again now that this question came up again (depressingly) quickly after the SNB announcement this morning that they will buy “unlimited quantities” of EURCHF. The MNB make the very clear separation in currency move terms between risk premia which is a EURHUF, CDS and basis thing in their minds and growth which is a CHFHUF thing. Also remember how far households are underwater, this just makes them slightly less far underwater.

Any positive to households is also more than offset by weaker external dynamic going forwards and the recent very weak growth numbers which keep the financial stability and balance sheet risks still alive. The MPC is also still too concerned by EZ crisis to move rates, this is their primary driver for rates unchanged and if anything things seem to be getting worse on that front week by week. Also remember they didn’t cut before, even when CHFHUF was below their key 240 danger level. Also think about this- mortgage policy break-even is 190 in CHFHUF with EURCHF at 1.2 that implies that EURHUF is at 228… is that really going to happen? Even with EURCHF pegged, EURHUF is still going to have a positive and large beta to EUR.

We do not think EURCHF is going to rally significantly beyond 1.2 with the attraction to hold CHF as a safe haven still fundamentally there and simply neutralised by the policy action now taken. With the basis still outside -100, the CDS still over 300 and EURHUF still above 265 area we do not see the MPC cutting rates and still see rates on hold for the next year with an MPC ‘paralysed’ in a ‘do no harm’ mentality.

Poland: This is a marginal positive for households but again given a lack of further momentum in CHF from here we don’t see a huge impact. Given positive real disposable income growth going forwards this may allow MPC to maintain its (to market surprisingly) soft hawkish bias for longer.

Barclays, meanwhile, digs a bit deeper (wondering what will happend to the SNB if the euro does break up?):

Today at 9am the Swiss National Bank (SNB) set a minimum exchange rate of 1.20 Swiss francs per euro, with a commitment to buy unlimited quantities of foreign currency to maintain it. This measure is in response to the recent strong appreciation of the Swiss franc, which is posing downside risks to the Swiss economy.

The main risks are weakening activity as the export sector struggles with a strong franc, and deflation risks as falling import costs add downward pressure on inflation. Headline inflation for August came in at -0.3% m/m and 0.2% y/y in this morning’s release. We have found that several market participants are of the view that there is little downside to the SNB’s move as it puts a floor under EUR/CHF while reducing deflation risks.

The revealed preference suggests that the SNB had significant doubts about the measure, otherwise why was it not done earlier? So what is that downside? Assuming that the euro area problems persist (which seems to be a fairly safe assumption at present), the EUR/CHF price that would have prevailed absent the measure is probably going to remain significantly below 1.20. Given that, there is always the possibility that the market will test the SNB’s resolve, just as the ERM bands were tested.

It is true that in this case the SNB wants a weaker CHF and can print as much money as it wishes, whereas the ERM crisis was about central banks being unable to keep their currencies strong enough. But in both cases the key issue was whether there was enough political will to maintain the level come what may. Buying unlimited amounts of EUR, even if diversified to some extent, does run the risk of losing a lot of money if the floor is ever abandoned and increasing the difficulties of controlling monetary policy.

The SNB has effectively set its monetary policy with reference to the value of the EUR. But who knows what that value will be in the future?

If so, this policy will have to change at some point, and the pressures are not going to be to the topside of EUR/CHF if that’s the case. It is possible that markets will backwards induct to question the EUR/CHF floor now. Anchors in quicksand can lead to shipwrecks. We see little upside to EUR/CHF in the short run, as Eurozone debt issues are unlikely to be resolved soon and could easily deteriorate further. And with little carry to pay, the cost of keeping short EUR/CHF positions is relatively low. This is consistent with the positions we are seeing from some clients who are short EUR/CHF: risk/reward still looks attractive if one considers that the success of this measure partly hinges on the Eurozone’s own success.

Given the risks to central banks around the world, with stakes much higher now, how does one ever take into consideration if Germany leaves the monetary union.

First HSBC, who are not too convinced the move will work:

The SNB’s move today is somewhat sudden and aggressive. However, it needs to be aggressive to turn the tide for the CHF and to take the shine off its safe haven status. So, this is an endurance contest whereby the SNB needs to fight hard against a market that could soon test its resolve.

Putting EUR-CHF at 1.20 today is the easy part. Keeping it there or significantly above will be difficult if the world still looks like a gloomy place. The local media just on Sunday cited the main business lobby group in Switzerland arguing that the SNB should adopt an initial target range of 1.10 to 1.15 for EUR-CHF, but according to the lobby group a level of 1.20 made ‘economic sense’. It seems like the SNB was thinking along the same lines. This same newspaper also reported on 14 August that a minimum floor for EUR-CHF could be announced.

In other words the SNB’s move had been in the pipeline. The SNB has been down this road in the past back in October 1978 when a floor for DEM-CHF was introduced. But this ultimately had undesirable consequences as inflation skyrocketed, reaching over 7.0% in 1981. Not great for a central bank that is meant to be focused on price stability.

The Swiss authorities will remember the experiences of the late 1970s and such a fight against CHF strength was difficult. Furthermore the problems the Swiss faced back then are somewhat similar to today. That is, the CHF strength back then was partly a function of lax US monetary policy and a weak USD – sound familiar? The upward pressure on the CHF only started to fade when the US in particular started to fight back against inflation. This should serve as a reminder that if the Swiss go down the same path as before, their concern over the CHF will not truly dissipate until the world outside Switzerland looks like a better place. The past shows that there were high costs associated with a temporary move towards targeting the exchange rate.

Rabobank is of the opinion that for the SNB, euro losses are worthwhile as long as Swiss exporters get to benefit from the move:

The SNB has upped the ante this morning by acknowledging that it is ready to buy foreign currency in unlimited quantities and by setting a floor well above recent levels at EUR/CHF1.200. In recent sessions the market appeared to take the view that EUR/CHF was not quite at levels which would trigger a reaction from the central bank.

Insofar as the Swiss franc is effectively a gauge for market nervousness in general but specifically with respect to the Eurozone crisis, the SNB has in effect put itself in direct conflict with the markets’ strong desire to buy safe haven assets. This move into safe haven is clearly reflected in the gains in assets such as gold and bund prices this week.

In the very probable event that the Eurozone crisis worsens in the coming months, intervention could be very costly for the SNB. While SNB share holders were dissatisfied last year with the losses that resulted from intervention it could be that the Swiss authorities now view the losses from intervention as a cost worth bearing if it affords exporters and the wider economy protection from excessive currency strength. It will be the direction taken by the Eurozone crisis that will determine how successful the SNB will be in protecting the CHF from strength in the coming months. While it will continue to be difficult to engineer a clear trend higher in EUR/CHF, the SNB should at least be able to buy a less strong franc.

BNY Mellon’s Simon Derrick, though, offers arguably the most interesting insight. Not only is there a certain deja vu to the whole thing — for example he warns of the monetary base explosion to come — he wonders about where those euros might end up being invested (i.e. will they start doing a China, but this time rather than investing in USTs, will they perhaps start pumping the money into eurozone bonds?):

Today’s announcement from the SNB was, as we have noted before, not the first time that the Swiss authorities have attempted to establish an exchange rate target in order to fight against persistent inflows of capital looking for a safe haven.

In late 1977, the SNB had begun to intervene heavily to fight against a rising tide of inflows. However, in the face of rising inflation elsewhere and the SNB’s explicitly monetarist beliefs, money continued to pour into the currency. As a result by September 1978, the SNB had begun to contemplate introducing an exchange rate target zone against the DEM. The idea is familiar enough one today: the SNB would conduct non-sterilised purchases of foreign currencies until the exchange rate had reached the lower bound of the target zone.

At the beginning of October 1978, it announced that, rather than go for a band (akin to the old ERM bands) it would instead fix a temporary exchange rate target (the aim being to simply keep the CHF weaker than a certain level against the DEM). In other words, the SNB drew a “line in the sand” that was very similar to that announced today. In strict currency market terms, the policy did work with the CHF moving back to more realistic levels. However, this came at a huge cost to the SNB as the monetary base exploded.

Indeed, the SNB did not fix a monetary target for 1979 because of the uncertainty engendered by its new policy. By 1982 the bank had seen enough and abandoned the policy, reckoning that the inflationary impact was simply too great a cost to bear. Inflation today, of course, is hardly the issue.

Indeed, in its statement this morning it made it clear that it had taken the decision to force EUR/CHF above CHF 1.20 in part to fight against deflationary forces. As such, a significant pick up in inflationary forces in the months ahead would likely be welcomed. However, today’s decision brings with it other implications. In its statement the SNB noted: “With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20.

The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.” In short it is prepared to buy unlimited amounts of EURs (if we assume that this is where the majority of the recent inflows have come from).

These fresh FX reserves must, in turn, be invested in the appropriate instruments. Unfortunately, this comes at a time when the SNB must already be feeling the pressure from managing its existing reserves. It announced at the end of July that it had made a CHF 9.9 Bn loss on its foreign exchange holdings for the first half of the year, arguing: “The appreciation of the CHF against all major investment currencies resulted in substantial valuation losses.”

Although today’s move will help out in terms of the valuation in local currency terms (which is how the SNB reports) given that EUR/CHF stood at CHF 1.22 at the end of June, this may be scant comfort given the rising pressures in the Eurozone bond markets and the continued growth in its reserves in recent months to a substantial CHF 253 Bn (albeit that the latest increase came about as a result of their actions in the swaps markets in August).

Little wonder then that Frankfurter Allgemeine Zeitung reported on Saturday (a story subsequently picked up by Dow Jones Newswires) that the SNB had decided that it would only acquire German and French bonds, as it deemed them the most secure and liquid within the currency block. This was a change to its actions in 2009 and 2010 when the SNB reportedly didn’t limit its purchases. This, then, is the situation the SNB would seem to find itself in.

By its promise to buy “unlimited quantities” of foreign currencies it has effectively agreed to provide an artificially cheap exchange rate for anyone who wishes to seek a safe haven from the uncertainties of the Eurozone (with, presumably, the lion’s share coming from southern Eurozone nations such as Italy and Greece). However, rather than recycle these funds back into the markets they came from, the money will instead be invested into French and German debt (if we believe the FAZ story).

In other words, the money continues to flow from the south to the north of the continent (albeit by a slightly indirect route). Although this may do something to mollify any potential criticism from a domestic audience (Christoph Blocher, the person behind the Swiss People’s Party, has already called for Philipp Hildebrand to resign after last year’s losses), it also suggests a less than wholehearted belief by the SNB in the outlook for the more peripheral Eurozone nations. This, we suspect, is the darker message from the stories that have emerged over the past few days.

Thank you to FT Alphaville for the compilation

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