Fundamental Forecast for Swiss Franc: Neutral

- Swiss Producer Prices Rebound From Record Low in August
- Industrial Production Set Fresh Record Low in Second Quarter
- Annual Retail Sales Outperform Expectations, Grow 1% in July
- SNB Keeps Rates Unchanged, Upgrades Inflation Forecast

The standby counter-question to anyone seeking to forecast the direction of the Swiss Franc in recent months has been “against what?” In trade-weighted terms, the currency has been confined to a narrow range since March, when the Swiss National Bank intervened into the markets to drive down the exchange rate and pledged to keep a lid on further appreciation as a bulwark against deflation (a stronger currency boosts purchasing power, effectively reducing prices). Markets in the Euro Zone account for close to 60% of Swiss export demand, so in practical terms, reining in the Franc in trade-weighted terms has essentially meant controlling the EURCHF rate (which the SNB has openly discussed). Elsewhere, the Swissie has slipped against the commodity currencies and the Pound but has managed to advance against the US Dollar and the Yen. This is a reflection of the interest rate environment. The Australian and New Zealand Dollars, where 3-month Libor rates have stayed steadily above those of the Franc, have outperformed. The Pound and the Canadian Dollar have seen fewer gains because, while still in their favor, the yield gap has narrowed considerably since the beginning of the year. Finally, the Yen sold off as a rapidly shrinking rate spread erased any advantage the otherwise markedly cheaper Japanese unit had over the Franc, while the US Dollar fared worst of all as its 3-month Libor tumbled to sink below that which is paid on the Swiss currency.

What does this mean for the week ahead? If carry flows are the primary catalyst behind recent price action, currency traders ought to have their eye on the trajectory of risk sentiment, meaning global stock and commodity prices. We have long argued that the markets have done too, much too fast since risky assets began to rally in March with global equities trading at levels unseen since 2003 relative to earnings. The world economy grew nearly 3% in real terms that year, whereas virtually every credible forecast calls for the first post-WWII contraction in real growth in 2009, pointing to lackluster revenues and overextended asset prices. Further, trading volumes have steadily declined for the bulk of the equity rally (the past 5 out of 6 months). While some of this may be chalked up to a seasonal slowdown that is typical for the summer, it may also be hinting at waning conviction behind the up move and a forthcoming reversal as traders return from holiday and volumes pick up into the Fall. While timing this reversal has proven elusive, we can say that when it does occur, the accompanying liquidation in carry trade positions will likely push the Franc higher against the Antipodeans and (to a lesser extent) the Pound and the Canadian Dollar. Meanwhile, a surge in demand for safety will likely boost the US Dollar as well as the Japanese Yen, eroding the Franc’s recent gains against those currencies.

Turning to the economic calendar, the August trade balance report will be of interest: exports look set to decline considering last week’s dismal industrial production data, but the appetite for imported goods is proving difficult to gauge. Indeed, domestic demand may have recovered a bit considering the recent moderation in retail sales figures, but the trend in receipts is undeniably pointing lower while unemployment rises and consumer confidence continues to set record lows. The release of updated economic forecasts from the government’s State Secretariat for Economic Affairs (SECO) will be notable in terms of how it compares to last week’s upward revisions to the growth and inflation outlook of the SNB.

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