The notes from the US Fed’s June meeting hinted at further interest rate cuts, and Federal Reserve chair Jerome Powell spoke on 10thJuly to reconfirm the direction of travel. Referring to a range of challenges facing the US and global markets, he explained that the central bank prioritises continued economic expansion and that it will “act as appropriate”.
Powell has referenced “crosscurrents”, which may allude to the fact that the hard data coming out of the US is somewhat conflictory at the moment. Last week’s job figures were significantly better than expected, but on the other hand business investment is down across the US. At moments like this central bankers can pick out the reports that best suit their motives and Powell’s commentary yesterday drew heavily from those reports suggesting the US may need a rate cut.
Interpreting such statements can often involve a degree of reading between the lines. Yesterday, Powell gave so many dovish pointers that it is more a case of analysts reading what is right in front of them.
“There is a risk that weak inflation will be even more persistent than we currently anticipate.”
“Overall growth in the second quarter appears to have moderated.”
“It appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the US economic outlook.”
“Inflation has been running below the Federal Open Market Committee’s (FOMC) symmetric 2 percent objective.”
If a rate cut does not materialise then Powell will likely be spending his summer attending ‘Communications Delivery’ workshops. The equity markets take the signals as a buying signal and CME group reports that traders are pricing in the chances of a rate cut before the end of July at 100%.
Powell’s prepared testimony to the House Financial Services Committee alsotriggered across the board weakness for the dollar. One particularly interesting pair is USD/CHF.
Both of these currencies have characteristics that mean they play ‘roles’ within the global markets as well as reflect the underlying health of the national economy they represent. The US dollar is the global currency. It is readily accepted as fiat currency even outside the US and in some insecure areas of the world it actually operates as a de facto currency instead of the local version.
The Swiss Franc is a ‘safe haven’ currency – this status is tied in with the country’s neutral political status and reputation for discreet banking. When the capital that flows through the global markets needs somewhere to rest for a while, a simple risk return style question arises. Whilst Swiss banks currently apply negative interest rates, the perceived security of Swiss banks encourages cash deposits during times of geo-political unrest. The thinking being that it’s better to lose out on yield rather than run a risk of losing the whole amount.
There is also a heightened amount of news flow in play, all adding to the mix and bringing about increased price volatility in the currency pair. Both the US and Switzerland are engaged in trade wars/trade negotiations; the US most notably with China, and Switzerland with the EU – as highlighted by the recent impasse between the two regions on the subject of share dealing equivalence.
The 24 hours prior to Powell delivering his statement, the USD/CHF saw trading within a tight downward range but inching towards the psychologically important 0.9900 support level. The text of Powell’s report then pushed USD/CHF below the 0.9900 level.
The below chart from SmartTrader shows USD/CHF now forming a downward channel:
The strengthening of the franc will not be welcomed by the Swiss National Bank (SNB), which has since 2015 held interest rates at negative levels to try and discourage capital inflows. The intention being to weaken the currency and avoid the country ‘importing inflation’. As David Cottle points out in DailyFX:
“History has shown that nothing messes with that institution’s plans quite like a new commitment to easy money from the eurozone.”
Swiss interest rates:
There’s not much room to the downside for CHF interest rates, suggesting the currency will continue to strengthen. The below graphic shows the current forecast is that the SNB announcement on 19thSeptember will see rates held at current levels.
The central banks of other major nations have varying capacity to make cuts. The fact that the ECB has little room to play with does little to deter them from giving signs that further rates are coming.
Higher volatility means trading opportunities and Forex dealers have been busy monitoring and reacting to recent events. The USD/CHF pair is the fifth most commonly traded pair in the global Forex market, so liquidity is not normally an issue.
One thing to bear in mind is that the Swiss currency, Swiss interest rate policy and the country’s regulatory framework contain certain peculiarities. Most are due to the safe haven characteristics of the currency, which means domestic interests and those of international investors are not always aligned. Some would say the Swiss economy sometimes operates a bit like a hedge fund. The tag is a little bit unfair, but sticks. Forex traders need to be aware of the possible ‘distortions’ to the market.
There are several examples of the Swiss central bank taking action that has surprised the markets. Uncontrolled capital inflows have historically made Swiss exports uncompetitive. To counter this, in 2011 the SNB set a maximum EURCHF ‘peg’ at the 1.2000 level. In January 2015 it removed the peg with no notice, causing a 20% intra-day decline in EURCHF.
The ZeroHedge website reports another anomaly. The SNB’s negative interest rate policy means account holders in Switzerland pay for the privilege of depositing funds. ZeroHedge reports that in 2017:
“SNB earned 32 times more than the 85 Swiss private banks (Pictet, Mirabaud, Lombard, UBP, J. Safra) for twice less assets.”