SNB takes action against strong CHF

BBH CurrencyView

• US growth concerns and downgrade risk remain in play after budget deal
• Euro zone periphery remains under pressure as ECB meets Thursday
• SNB takes action against strong CHF; spike in EUR/CHF offers good entry point to go long CHF

The dollar is mixed into the London morning, falling around 1% against the euro and the Scandies but rising 1.3% against CHF following action by the SNB. USD/JPY is also higher, supported by continued verbal intervention by Fin Min Noda. Gold and silver futures are up 1.5% and 2.5% respectively, as true safe-haven assets become increasingly scarce. Portuguese 3-month bill auction was marginally encouraging, selling its full allotment at an elevated rate of 4.967% (but lower than that of the July 20 auction at 4.982%). Still, shorter dated Portuguese and Greek yields are up some 30-50 bp, though moves in longer dated yields are more subdued with Spanish and Italian 10-year down 11 and 8 bp. Equity markets are mixed after the huge drops yesterday. Asian indices closed sharply lower but European stocks are mixed and S&P futures are pointing to a 0.7% higher open.

Global backdrop remains unsettled. Euro zone retail sales were stronger than expected, but Friday’s jobs report is key as markets increasingly concerned that fiscal tightening could trigger a US double dip. Bloomberg consensus is for +85k in NFPs vs. +18k reported in June. ADP report today is unlikely to have much impact after last month’s spectacular miss. With regards to US ratings, both Fitch and Moody’s have weighed in, portraying the recent budget deal as a good first step but saying more must be done to avert a ratings downgrade. China rating agency cut the US overnight to A, on par with Russia and South Africa but below China. Its ratings are in some cases closer to our proprietary model than the major agencies are, but we disagree with its US rating as we view it as AAA (barely). Still, we think that markets are resigned to a US downgrade by at least one of the major agencies.

SNB takes measures on Swiss franc strength. However, they are unlikely to have much impact on the Swiss franc’s trajectory as long as global risk is driving demand for the currency. If EM can’t stop that wall of money from strengthening their currencies, is seems unlikely that DM can either. SNB increased excess liquidity in money markets via an increase in banks’ sight deposits at the SNB to CHF80bn from CHF30bn currently. SNB also narrowed its target range for the three-month Libor interbank rate to 0.00-0.25% from 0.00-0.75%, although this move is symbolical given that CHF inflows have dragged volume-rated market repo rates to a one-year lows, just above 0.064%. SNB said that the appreciation of the Swiss franc has “accelerated sharply during the last few weeks” and that further measures will be considered to weaken the Swiss franc if necessary. After SNB move, we think market speculation on BOJ taking action at its meeting this week will pick up.

The euro zone periphery remains under pressure. ECB meeting on Thursday takes on greater importance given intensifying stresses in the euro zone. With SNB easing monetary conditions, can the ECB continue to focus on inflation risks? While it may be too early for a shift, markets will be watching to see if Trichet portrays a hawkish stance with his coded language. Meanwhile, Italy’s Berlusconi will speak before parliament today, while Spain’s Zapatero canceled his holiday in order to address problems in Spain. We remain skeptical that all this talk will yield much near-term in the way of policy responses. Since the EU summit was less than two weeks ago, we think it will take another big leg down in markets to get the next policy response from the EU. As such, today’s move in EUR/CHF offers a good entry point for long CHF positions in anticipation of further euro zone stresses.

Turkey announced an extraordinary central bank meeting for Thursday. We think that the target rate will remain on hold for the foreseeable future, and that the only possible concession would be to narrow the interest rate corridor by raising the borrowing rate, currently at 1.5%. This would help reduce liquidity in the interbank market. Inflation figures released today came in once again lower than expected, representing another small victory for the central bank. Headline CPI increased slightly in June to 6.31% y/y vs. consensus of 6.70% y/y. However, core CPI continues to trend higher to 5.43% y/y, rising the last 9 consecutive months. Other indicators also suggest that the risks are tilted towards overheating. In the end, there is no substitute for central bank credibility and as long as they don’t establish a clear anchor there will be no support for Turkish assets beyond broad trends in risk appetite and bouts of short covering. Moody’s warned that rising external imbalances could “stall positive ratings momentum” for Turkey, and comes after Fitch did the same last month.