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Franc Cap Rendered Obsolete in U.S. Ceiling Dispute

Swiss Franc
Morgan Stanley predicts the franc will weaken to 1.25 per euro by Dec. 31 and to 1.35 by the end of 2014, while Alvin Tan, a director of foreign-exchange strategy at Societe Generale SA in London, estimates it will plunge almost 10 percent to 1.35 next year. Photographer: Valentin Flauraud/Bloomberg

When Swiss National Bank President Thomas Jordan said this week he hasn’t had to intervene to weaken the franc for more than a year, he acknowledged what traders have long argued: the currency’s cap may be redundant.

The franc has dropped 0.3 percent this month amid the U.S. government shutdown and debt-ceiling debate against a basket of nine other major currencies tracked by Bloomberg. Japan’s yen, also perceived as a haven in times of turmoil, has risen 0.5 percent, while the dollar has gained 0.4 percent.

During the height of the European sovereign crisis in September 2011, so much money flowed into Switzerland that the franc approached parity with the common currency, prompting the Swiss National Bank to set a ceiling of 1.20 per euro. As Europe’s woes diminish, cash is fleeing the franc, to the extent that even speculation of a U.S. default isn’t enough to make it rise. That’s easing the cost of defending the cap, which last year equated to almost a third of Switzerland’s economy.

“The market will do the SNB’s work for it,” Alvin Tan, a director of foreign-exchange strategy at Societe Generale SA in London, said in a phone interview yesterday. “We’ve seen risk premium creeping out of the euro zone because the risk of a breakup is receding, and consequently the Swiss franc has been slowly grinding lower.”

Holdings Drop

Franc deposits held by foreign banks with their Swiss counterparts fell for a fifth month in July, SNB data showed Sept. 23. Holdings dropped to 96.2 billion francs ($106 billion) from 99.8 billion francs in June, after reaching a record-high 127.7 billion francs in February.

Morgan Stanley sees investors returning to borrow francs at Switzerland’s low interest rates and investing the proceeds where yields are higher, a strategy known as the carry trade. The SNB’s benchmark interest rate is a range of zero to 0.25 percent. The currency fell to a two-week low of 1.2329 per euro today before trading at 1.2323 as of 2:56 p.m. in New York, showing the cap of 1.20 that Jordan defended as still “the right tool” may not be necessary.

“The franc will return to the more traditional role as a funding currency in the coming year, and as a result we’re likely to see it coming back under pressure,” Ian Stannard, the head of European foreign-exchange strategy at Morgan Stanley in London, said in an Oct. 8 phone interview.

Enforcing Cap

Morgan Stanley predicts the franc will weaken to 1.25 per euro by Dec. 31 and to 1.35 by the end of 2014, while SocGen’s Tan estimates it will plunge almost 10 percent to 1.35 next year. The median estimate in a Bloomberg survey of more than 30 analysts sees the Swiss currency declining to 1.24 per euro by end-2013 and 1.30 a year later.

The Zurich-based SNB implemented the cap in September 2011 after the franc soared to 1.0075 per euro from almost 1.50 at the start of 2010. It spent 188 billion francs enforcing the limit last year, equivalent to almost one-third of Switzerland’s annual output.

“Despite recent turbulence on foreign-exchange markets,” the franc “has settled against the euro since September 2012 at slightly above the minimum exchange rate of 1.20,” Jordan said in Washington on Oct. 8. “Accordingly, the SNB did not have to enforce the minimum exchange rate for over a year now.”

Switzerland’s target for its main interest rate is the same as the range that the Federal Reserve has maintained since December 2008, and compares with rates of 0.5 percent in the euro region and U.K. and 2.5 percent in Australia.

Annual Decline

The franc has fallen 0.5 percent against a basket of nine developed-market peers over the past week, according to Bloomberg Correlation-Weighted Indexes. The yen dropped 0.1 percent after reaching an almost two-month high of 96.57 per dollar on Oct. 8.

Switzerland’s currency has slid 2 percent against the euro this year, on pace for its first annual decline since 2007, when the worst financial crisis since the Great Depression began. It has gained 0.5 percent versus the dollar.

The U.S. government partially closed on Oct. 1 in a dispute over funding President Barack Obama’s health-care overhaul. Obama and Congress now have only a few days to raise the nation’s $16.7 trillion debt ceiling before U.S. borrowing authority lapses on Oct. 17.

Economies Recover

Even as the tussle in the U.S. roils global markets, the continuing recovery of major developed nations is leading some investors to see less need to buy assets they consider havens.

BlackRock Inc., the world’s biggest money manager, said Oct. 2 it was adding to its bet that the franc will fall versus the 17-nation euro because of “the ongoing unwind of safe-haven positions in financial markets.”

U.S. gross domestic product will grow 2.65 percent in 2014, while the economy of the euro area, which earlier this year exited its longest-ever recession, will expand 1 percent, according to Bloomberg economist forecasts. The franc has depreciated about 2 percent versus the euro since the ECB announced its still-unused Outright Monetary Transactions bond-buying program just over a year ago.

Even after the slide, the franc is the most-overvalued currency relative to the euro of 12 peers tracked by Bloomberg, another reason it may have been kept from rising amid the U.S. debt-ceiling debacle. It’s 30 percent overvalued on a purchasing power parity basis, compared with 2.3 percent for the yen.

The SNB’s Jordan said this week that the franc “is still high” and the cap remains the “right tool” for Switzerland.

Citigroup Inc., the world’s second-biggest foreign-exchange trader, agrees, while acknowledging that the debate around abolishing the currency ceiling has become widespread.

“With the euro-zone crisis more or less gone and deposit inflows reversing, some clients are making the case that the SNB may step away from the peg,” Valentin Marinov, the head of Group of 10 currency strategy at Citigroup in London, said in a phone interview yesterday. “The peg is still very important and is likely to remain in place for the foreseeable future.”

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