The Weakness In The Swiss Franc Is Not A Buying Opportunity
The Swiss franc has seen a sharp fall since late June. We have forecasted a lower franc based on falling Eurozone risks for some time. The trigger came from the comments of the Swiss central bank. We expect a lateral move over the coming months.
We adjusted our 3-month target to the same level as our existing 12-month target of 1.12 (value of 1 euro). The franc remains overvalued versus its long-term fair value but that should remain the case in the future.
The Trigger For A Long Awaited Normalization
We have been arguing that the Swiss franc is overvalued for some time. Waves of risk aversion periods due to the US and a number of European elections (including Brexit) have led to impressive inflows into Swiss franc over the past years. This came despite negative interest rates.
The recent months have brought some relief in terms of Eurozone risks and fears regarding a “hard Brexit” have also been reduced. The trigger for the currency adjustment probably came from the recent comments by the Chairman of the Swiss central bank who reiterated that there is no scope for higher interest rates and that a further increase in the balance sheet would be possible if needed. On the contrary, market expectations for the ECB have been moving towards an earlier than expected policy normalization.
We are somewhat more cautious on the outlook for the ECB compared to market consensus. There is a clear improvement in economic growth and confidence from both consumers and business but the momentum seems to be slowing somewhat. Further, inflation is still muted, despite the rise in oil prices and wage growth is hardly picking up.
Stabilization Of The Franc In The Short-term
Despite the fact that the franc is still overvalued based on long-term fair-value measures (see section below), we see limited downside after the recent sharp fall. As discussed, we see the expectations of a rapid normalization of the ECB policy as overdone. The ECB will probably announce a further reduction in the monthly bond purchases but the adjustment will be very gradual and the broad-based strength of euro suggest that the ECB is not in a hurry. Technical indicators and overbought conditions suggest a stabilization over the coming weeks. We adjusted our 3-month target to the same level as our existing 12-month target of 1.12. Based on our forecast of the euro against the dollar this implies a 3 month target against the US dollar of 0.99 and 1.02 on a 12-month horizon.
Economist often use the purchasing power parity as forecasting tool for the long-term fair-value of a currency. This is based on the assumption that the value of a basket of goods should converge when it is measured in the same currency. Based on the measure proposed by the OECD, the fair-value of the franc is around 1.60 (value of 1 euro). Many studies suggest however that a full convergence to this level is unrealistic over a foreseeable future. Some authors suggest a half-life approach i.e. using an adjustment of half of the deviation from the fair value. Such an approach would suggest a medium-term level of 1.35 (value of 1 euro) which seems more realistic to us. The current environment should not be seen as a buying opportunity for the franc.