More Thoughts on Switzerland and Why the Euro is Not Lower

Investors are still trying to get their heads around the SNB's preliminary indication that is reserves rose to CHF232 bln in May from CHF153 bln in April. This represents more than a 50% increase in reserves in a single month.

It would be tempting to attribute this to valuation changes. As we have noted when looking at the IMF's COFER data, valuation shifts often swamp the actually flows. However, in this case it is largely a reflection of SNB intervention. During the month of May, the Swiss franc declined 6.7% against the dollar, while the euro declined by 7.4%. That 1.3% difference is a rounding error when considering a more than 50% increase in the valuation of SNB reserves.

The SNB's balance sheet is around three times larger than it averaged in the pre-2009 period, prior to the quantitative easing. Such an explosion in the SNB's balance sheet has not, though, undermined the Swiss franc, which set a new record high vs the euro today.

The SNB appears to have changed its tactics. It does not appear to be defending a particular level as it had seemed to do in the past, like CHF1.50, then CHF1.40. Instead, it's intervention now may be more properly thought of as a smoothing operation, like blowing air under a parachute.

In addition, there is some talk that the SNB is not intervening as much directly in the euro-franc cross, but is going through the dollar. Selling euros for dollars and buying dollars for francs, which might help explain the strange price action earlier today.

The SNB's task may prove increasingly difficult. It meets on June 17th for a policy meeting and it may very well revise up both growth and inflation, even though the Swiss franc's strength may have a deflationary thrust.

The government has revised up this year's GDP forecast to 1.8% from 1.4% and has revised up exports as well. Next year's growth forecast was cut, however, to 1.6% from 2% and exports appear to have been revised down as much as this year's were revised up. Unemployment forecast was also revised lower.

Switzerland reported May consumer prices earlier today. On the month CPI slipped 0.1% after a 0.9% rise in April. The year-over-year rate slipped to 1.1% from 1.4%. The 1.4% reading in both March and April was the highest since late 2008. In June 2009, the CPI rose 0.2%, so there might not be a significant change in the year-over-year reading this month, but look for more significant rise in July when last July's 0.7% decline drops out of the year-over-year measure. Of course, this is not to suggest that Swiss inflation is a problem,. just simply looking at the math. Core inflation made a new low in May of 0.2% year-over-year.

In terms of the euro, the SNB appears to have purchased around 55 bln euros in the month of May. This is simply an incredible amount. Assuming that the SNB is QE is still operative and it is selling Swiss franc and buying foreign--primarily European bonds, consider that the ECB bought around 40.5 bln euros worth of European sovereign bonds in the secondary market. The time frames do not match up perfectly, but it would appear that the SNB bought more European bonds than the ECB itself.

Some observers ask, given the poor news stream emanating from the euro zone and the apparent lack of concern (except from time to time the pace of the move) by European officials, why is the euro not lower. Part of the answer, and admittedly only a part, is that there is a very large buying on the other side who does not seem to really have to mark-to-market like private sector do.