Testing the SNB's Resolve and Notable Reserve Developments

In the holiday thin markets, the Swiss National Banks' resolve to defend the cap in the franc has been challenged. At the end of last week and again today, it appears the CHF1.20 level has been breached. The SNB is believed to have intervened to defend the cap that announced early last September.

The combination of thin markets, increasing tensions in the euro zone, reflected in the increase in Spanish and Italian bonds and CDS pricing (in absolute terms and relative to Germany), and some ideas of weakening official resolve in Switzerland, seemed to have encouraged the test.

The prestigious Swiss Nation Bank has an interim head but a final decision of Hildebrand's successor has not been made. The SNB is due to discuss the issue at the end of the week and may make a recommendation at that time. The interim head Thomas Jordan is thought to be the favorite.

In the past, the SNB has been forced by rising price pressures to abandon unconventional efforts to curb the franc's strength. News earlier this last week that March inflation rose 0.6% (month-over-month), twice the pace seen in February and more than the 0.4% the Bloomberg consensus expected, may have encouraged the pressing of the central bank. However, the deflation on a year-over-year basis increased to -1.0% from -0.9% in Feb. Moreover, at last month's meeting, the SNB forecast a 0.6% fall in CPI this year before a small increase next year (0.3%).

Switzerland also reported a rise in March manufacturing PMI to 51.1 from 49.0. The Bloomberg consensus was for an increase to 49.5. It was the first reading above 50 since last August. This suggests Swiss tradeable sector may more resilient than officials may have feared. This was view also is supported by the larger than expected Feb trade surplus of CHF2.68 bln vs CHF1.80 bln consensus and CHF1.50 bln surplus in January. The next set of trade figures are due out April 24.

Nevertheless, on balance, there is no compelling reason to expect the SNB to give up its efforts to prevent further Swiss franc strength. With political challenges, particularly the French election, the lack of resolution on Greece and rising anxiety in Spain and Italy, if the SNB were to step away now, the market would rush into the Swiss franc.

Investors who do not have exposure to the Swiss franc still need to follow this developing story as the SNB is not likely to simply sit with the euros that it buys via intervention. Some observers see a pattern. After the SNB buys euros against the franc, it later sells the euros for other currencies, such as the dollar.

However, most recently there have been indications that the SNB has bought Korean bonds. A Korean official has indicated that the SNB may have bought KRW50 bln in 5-year government bonds and between KRW50-KRW100 bln 20-year bonds.

While market observers are well aware that central banks have been seeking to diversify reserves outside of the common majors (dollar and euros), most of the focus has been on the Australian, New Zealand, and Canadian dollars. Yet the SNB is not the only central bank to look more fondly at the Korean won. Reports suggest that the Malaysia and Thailand's central banks have already begun buying Korean bonds.

Thus far the SNB has successfully blocked the Swiss franc's appreciation relatively cheaply. Compare the bang it got from about CHF18 bln intervention last year with the record operations by Japanese officials. The SNB has various ways it can lean against the market and we expect it to do so. We would rather go with the SNB that fight it. The long Korean won short franc position looks interesting. The franc is currently just below KRW1240 and there is near-term potential back toward KRW1260 plus carry, but we would look for an opportunity to fade it.