Tags: Franc | Switzerland | US | CLI

Nothing Will Stop the Swiss Franc From Appreciating

Tuesday, 13 Aug 2013 12:16 PM

By Hans Parisis

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The Organization for Economic Co-operation and Development (OECD)'s Composite Leading Indicators (CLIs), which are designed to anticipate turning points in economic activity relative to trend, haven't changed significantly from their indication levels of where they were a month ago.

Of all the big economies, once again only the CLIs for the United States, Japan and the United Kingdom continue to indicate firming economic growth, which should, in the case of the United States, increase the probability the Federal Reserve could start tapering in September.

Remarkable and completely in contrast is the CLI for China, which now indicates growth is losing momentum. Its three latest monthly ratios to trend all came in below the 100-mark and are on a descending slope, down to 99.4 in June from 99.8 in April and 99.6 in May.

Brazil shows a similar situation, with growth also losing momentum, but on a steeper downward slope, down to 98.8 in June from 99.4 in April and 99.1 in May.

In Europe, we see the situation becoming somewhat timidly better. Nevertheless, it should be noted even Germany is not yet at a level of firming economic growth.

All this means, at least in my opinion, as a long-term investor I remain extremely prudent when it comes to investing in one or more of the major OECD economies because of the very simple reason the overall picture is one of clearly diverging growth trends among them all.

Yes, long-term investors who don't do their homework seriously could be bound for very nasty surprises in the foreseeable future. I don't think it's an overstatement to say: "Today, as a long-term investor we are not in an investor friendly 'Goldilocks' environment."

Coming back to the United States, it is evident that the upcoming economic data and the September employment situation will define for a great part if the Fed will finally decide to start tapering its quantitative easing (QE) program at its September Federal Open Market Committee meeting. That meeting will also will be associated with a "summary of the Fed's own economic projections" and a press conference provided by Fed Chairman Ben Bernanke.

Until then, we all will have to remain patient and wait and see if at that moment (historical?) in time the Fed will finally begin turning the U.S. monetary cycle that will impact the U.S. economy but also have global consequences, no doubt about that.

In the Federal Reserve Bank of San Francisco Economic Letter titled "How Stimulatory Are Large-Scale Asset Purchases?," San Francisco Fed Senior Economist Vasco Curdia and New York Fed Senior Economist Andrea Ferrero write: "[O]ur analysis suggests that communication about when the Fed will begin to raise the federal funds rate from its near-zero level will be more important than signals about the precise timing of the end of QE3."

In this context, it's clear that it's only a question of time until U.S. interest rates start their long-awaited rise/return to "normal/average" levels, which for the 10-year Treasury benchmark would ultimately represent yields in the 4 percent zone.

No, that won't happen overnight. The only known unknown is at what speed that process will eventually take place. Let's hope the markets won't force it, because that would be at a much higher speed than if the Fed induced the higher rates. If the markets set the law, high volatility probably would ensue and that could cause havoc in the broader markets. Of course, nothing is for sure. But if such a situation would have to take place, cash would be king once again.

Speaking of cash, it makes me spontaneously think about, of all circumstances, "safe-haven" currencies of which without any doubt the U.S. dollar remains the unchallenged king, but to which also the Swiss franc maintains a place at the top.

And talking about the Swiss franc, interestingly on Sunday, the Swiss daily "Le Matin" published an interview with the Swiss National Bank (SNB) Vice Chairman Jean-Pierre Danthine wherein he states: "The day the SNB decides to raise short-term interest rates, there can no longer be a restricting minimum exchange rate of 1.20 Swiss francs per euro."

To understand this in its context, we have to keep in mind that on Sept. 6, 2011, the SNB decided unilaterally to curb definitively speculation that had pushed the Swiss franc up to economically unrealistic levels against the euro, and because of that, the SNB put in place an "exceptional" maximum exchange rate of 1.20 Swiss francs per euro after the franc had performed its strongest rise of 38 percent to 1.042 Swiss francs per euro, up from 1.68 Swiss francs per euro in less than a year from Oct. 17, 2010. (A lower exchange rate of Swiss francs per euro means a stronger franc).

I think long-term investors who are interested in diversifying in the foreseeable future some amounts alongside U.S. dollar-denominated assets would do well to put the Swiss franc on their watch-list.

The day the SNB erases its 1.20 Swiss francs per euro line in the sand, which, by the way, is in the cards, the franc will quickly return to its historical place of a completely free safe-haven currency. The only thing that could jeopardize this would be a sudden resurgence of a full-blown euro crisis. While I don't think this will happen, it doesn't mean I'm turning optimistic on the future of the eurozone.

The latest poll by ING-DiBa AG and the University of Hohenheim in Germany shows that only 17 percent of Germans believe that the worst of the eurozone crisis is over, while 91 percent think the crisis will still go on for a long time. Only 10 percent of Germans believe that politicians are being honest with citizens regarding eurozone issues.

That said, when we take a somewhat longer-term view, I'm still convinced nothing will stop the Swiss franc from appreciating.

To me, there is no doubt we are moving slowly but surely into a higher interest rate environment over the whole spectrum of maturities, particularly in the better-performing economies like the United States and to which Switzerland also should be included.

From here on and until September is over, which is the month where we will also have on Sept. 22 the extremely important German national elections, it should not come as a surprise to anybody the markets could turn suddenly extremely volatile.

The only advice I can give is "Be prepared!"

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