The SNB is Preventing Needed Adjustment

The Swiss National Bank does not miss an opportunity to remind market participants that it is determined to cap the Swiss franc's appreciation. The cost of imposing its will appears to be rising. The Financial Times today reports estimates of the magnitude of its intervention range from CHF20 bln to CHF100 bln in recent weeks. Such a wide range illustrates the lack of transparency of the central bank's operations and the willingness of some participants to simply guess.

Swiss sight deposits have risen about CHF18 bln in the past two weeks and this would lend credence to the lower end the range of estimates. Some observers may also be confusing private sector activity for official intervention.

There is an important question though that the discussion about how much the cap on the franc is costing the SNB does not address. Simply put, why should a country such as Switzerland, with a net international investment surplus position and a trade and current account surplus, act to avoid currency appreciation?

If the Swiss economy was contracting, perhaps tightening of monetary conditions through the currency would not be desirable. But this is most assuredly not the case. Q1 GDP was reported earlier today. It rose 0.7% on the quarter. Recall that the strongest euro zone economy, Germany, expanded by 0.5% in Q1. The Swiss economy is expected to expanded by about 1% this year, while the OECD expects the euro zone economy to contract by 0.1%.

Switzerland's trade surplus has averaged CHF1.74 bln a month through April. During the same period last year, the monthly average was CHF1.64 bln.

The most compelling argument for the SNB is that the economy is experiencing deflation. However, putting a cap on the currency is too blunt of an instrument, especially if a) the franc is still overvalued on a PPP model and b) if commodity prices, including energy prices, are falling.

If nearly any other country did what the SNB is doing, they would be subject to heavy criticism. Imagine if Japan, which is now running a trade deficit and experiencing (chronic) deflation, surely the US Treasury, EU and various industries would object loudly.

Through its currency cap, the SNB is blocking important adjustments and rebalancing of the world economy, especially in Europe. It is distorting the signals to businesses by driving down 2-year rates to negative 41 bp. The 5-year yield is -7 bp. At 51 bp the Swiss 10-year yield is 30 bp below Japan's and nearly a third of the US yield.

Lastly, another point that is obscured by the discussion of the size of the SNB's intervention, the CHF1.20 floor for the euro and cap for the franc is arbitrary. The SNB repeatedly says that even at CHF1.20, the franc is still over-valued. The SNB could have picked a cap at CHF1.15 or CHF1.10 and not have a material impact on macro-economics.

The point here is not that the SNB is going to step away from the market. Rather, its franc cap is contributing to both foreign and domestic distortions and all the speculation of the size of the SNB's intervention, distracts from the fact that its economy appears strong enough to cope with a stronger franc and its cap is slowing if not preventing the larger adjustment process.