The recent appreciation of the Swiss franc is exaggerated and the central bank will intervene if need be, says Thomas Stucki. And still, the question remains how expensive the franc really is, says the chief investment officer at St. Galler Kantonalbank in an essay for finews.first.
This article is published on finews.first, a forum for authors specialized in economic and financial topics.
The Swiss franc increased in value against the U.S. dollar and the euro in recent weeks. The degree of change gathered pace after the U.S. put Switzerland back on a list of potential currency manipulators. The expectation that the SNB no longer is intervening in the currency market in the usual or, depending on your point of view, feared way, led to a small wave of speculation supporting the franc.
The short-term appreciation of the franc, however, is exaggerated. I also expect that the SNB will continue to intervene selectively against the franc if need be. Still, the question remains, how expensive the franc really is.
There is no easy answer to the question, whether a currency is over- or undervalued. The SNB estimates that the franc is highly valued. The bank refers to the real external value of the franc, which takes into account different inflation rates in various countries. The valuation models based on the theory of purchasing power parity are constructed in a similar fashion.
What these valuations have in common is that the results on over- and undervaluation depend strongly on the starting point. The models assume that the value of the franc was correct at the given point of time, something that can be questioned. If the franc is deemed expensive therefore has a lot to do with the point of time that the current value is compared with.
«The financial crisis and outbreak of the debt crisis in the eurozone hit the franc like an earthquake»
The trade-weighted value of the franc was extraordinarily stable between the year 2000 and the financial crisis. The euro was acclaimed as an alternative to the dollar and fluctuated between 1.55 and 1.65 francs per euro. It was a comfortable period for the Swiss economy, which came to an abrupt end when the financial crisis started. The financial crisis and the outbreak of the debt crisis in the eurozone starting in 2010 hit the franc like an earthquake.
Despite repeated interventions by the SNB, the euro dropped from 1.70 to 1.05. The trade-weighted value of the franc rose by almost 60 percent before the SNB applied the emergency break and introduced a minimum exchange rate of 1.20 francs per euro. So, compared with the time before the financial crisis, the franc today is indeed valued very highly.
«As inflation in Switzerland is lower than in the eurozone, the franc is cheaper than five years ago»
In the following years, the external value of the franc remained stable, before the decision to relinquish the minimum rate five years ago led to a renewed shift of the tectonics of the franc. The appreciation of the franc by some 10 percent, however, was minor compared with the previous earthquake and it didn't make up for much more than the aggregated advantage in inflation in the Swiss economy during the time of the minimum exchange rate.
Compared with that period, the franc today is neither cheap nor particularly expensive. Since the minimum rate was abolished, the trade-weighted value of the franc hasn’t risen. It even weakened over the past years. The appreciation versus the euro since mid-2018 from 1.20 to 1.07 is nothing more than a correction of the «phase of weakness». Considering that inflation in Switzerland is lower than in the eurozone and in the U.S., the franc remains cheaper today than five years ago.
«The franc's unbroken reputation as a safe haven»
Apart from the economic and political stability of Switzerland, it is low inflation that is the main contributor to this movement. Therefore, an average appreciation of between 1.5 percent and 2 percent a year is viable. There will always be periods when the franc will appreciate more for a short time. That’s due to the franc’s unbroken reputation as a safe haven.
At the same time, the franc is an easy victim for currency speculation, because, despite its importance, it is a «small» currency where a comparatively small trading volume can achieve a substantial change in price. The SNB will continue with its targeted interventions in the currency market and make speculation on a strong franc a risky business. But it will also, and rightly so, allow the franc to appreciate against the euro to the tune of two to three centimes per year.
Thomas Stucki is the chief investment officer at St. Galler Kantonalbank. He has a Ph.D. in economics from the University of Bern and is a CFA charterholder. Before joining St. Galler Kantonalbank, Stucki was head of asset management at the Swiss National Bank, in charge of managing its currency reserves.
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