Will Negative Swiss Rates Reduce CHF Demand?

Over the past 24 hours, capital markets have managed to navigate the last of the significant central bank scheduled meetings for this calendar year with the conclusion of the Federal Reserve’s pow-wow yesterday and this morning’s defensive Swiss National Bank (SNB) meeting. Investors must expect outlying central banks, like the People’s Bank of China (PBoC) and Central Bank of Russia (CBR), to remain the unknown factors concerning their respective monetary schedules. Apart from a few remaining economic releases, fear and innuendo, coupled with lack of market participation during the festive season, should manage to keep market volatility ticking over, through the turn, and into the new year.

Yesterday’s dollar rally was ignited by the Fed’s statement which signaled the bank’s policymakers are shifting to a more hawkish stance while expressing caution about the economy. The buck continues to benefit from an ideal mix of global and domestic equity gains, and a gradual rise in U.S. yields. Others, like the yuan ($6.1381), continue to buckle under reports of a more flexible currency regime. The EUR (€1.2300) has its own issues. It’s being ‘jobbed’ by various central banks that are in fact natural sellers of the single unit to rebalance reserves after various global interventions — think of the SNB and Russia’s defense of the rouble ($62).

A Strong Yen No More

The Fed’s remarks on policy intentions for next year seem to have finally helped to put a stop to the downward reversal in USD/JPY (¥118.50). Once again the yen bear seems to be trading in familiar territory after the Federal Open Market Committee replaced the “considerable time” component of its statement with the pledge to be “patient in beginning to normalize the stance of monetary policy,” while recognizing further improvement in U.S. labor market conditions. In terms of economic projections, the Fed raised this year’s outlook while lowering its unemployment estimates for the next three years. Officials also lowered their median federal-funds rate forecasts by 20bps, 37.5bps, and 7.5bps, respectively.

The market to date has been looking for a hint on timing, and it may have got it, or many participants think they have. During Fed Chair Janet Yellen’s testimony, she indicated that “patient” means the policymakers will not begin the normalization process “at least for the next couple of meetings.” To Yellen, a couple means two. The fixed-income traders have taken her at her word and are pricing in higher U.S. rates to begin as early as April. The potential of rate divergence sooner from the Fed’s perspective will only continue to support the dollar on pullbacks against the majors.

The SNB Pulls the Trigger

The SNB moved to negative interest rates (-0.25%) on sight deposit account balances at this morning’s central bank meeting. Policymakers repeated that the CHF currency cap (€1.2000) remains their “key policy instrument,” and are prepared to take further measures if necessary. That means intervening to buy copious amounts of foreign currency to defend the minimum exchange rate.

SNB Chairman Thomas Jordan indicated that negative rates would apply on the same day as the next European Central Bank (ECB) meet in January. This would indicate that Swiss policymakers want to be in a position to preempt any ECB move and protect the EUR/CHF floor from the prospect that any ECB action that could create a strong demand for safe-haven assets like the CHF. It’s not just the ECB, developments in Russia continue to favor the CHF, and without the Swiss FX floor, CHF price stability would be “seriously compromised.”

Will Negative Swiss Rates Be a Detractor?

Applying negative rates is an obvious defensive move, similar to a hike (CBR to +17% earlier this week), but will it work? A small discount is neither a natural detractor nor a massive hike — when investors lose confidence in a currency it’s a war, just watch the rouble. For Swiss policymakers, they will have to gauge how deep into negative territory they will be required to go to discourage the demand for safe-haven product. Low negative rates are unlikely to reduce the CHF attractiveness. On the last go-around of negative rates in the 1970s, even -10% did not reduce the demand for CHF significantly. This is reason enough for fixed-income traders to begin pricing in further rate cuts by the SNB in 2015, especially if EUR/CHF cannot gain any traction and get off the floor (€1.2000).

The Yuan Cannot Hide

The Chinese yuan is trading atop of its six-month lows aided obviously by a stronger U.S. dollar, and on reports that the Chinese government would be open to a more flexible foreign exchange rate. This would imply that policymakers should be willing to allow the currency to depreciate. The market’s previous interpretations of the possibility of greater flexibility on Chinese exchange rates have predominately led to a stronger CNY. However, a few soft economic reports are beginning to change some investors’ minds (November housing figures remained weak). The lack of government and PBoC transparency will make for an interesting 2015 for the yuan.

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