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2006 Was a Very Interesting Year for the Swiss Franc

Friday, 22 December 2006 16:58:47 GMT  |  DailyFX Research Team

USD/CHF Outlook

2006 was a very interesting year for the Swiss franc, which rallied over 1000 pips against the US dollar, but sold off to six year lows against the Euro. Comparative growth rates as well as divergent monetary policies played a huge role in driving the currency’s movements this past year and will probably continue to in the months to come. 

 The increasing weakness of the US economy in contrast to the tight labor market and above trend growth in the Swiss economy pushed USD/CHF from a high of 1.3240 in March to a low of 1.1880 earlier this month.  As for EUR/CHF, even though the Swiss National Bank increased interest rates a few times this year, the European Central bank’s plans for even more interest rate hikes and the Eurozone’s relatively higher level of interest rates has kept the Franc weak against the Euro.  Looking ahead, low inflation has given the SNB little reason to step up their plans to raise interest rates, which for the time being, still makes the Franc an attractive carry play in the first quarter of 2007. 

More Rate Hikes from SNB?

On December 14, the Swiss National Bank raised interest rates by 25 bps for the fifth time in a year, taking the 3-month Libor target range to a mid range of 2 percent (the band is 1.5-2.5 percent). The released statement showed upward revisions to the GDP growth, which was revised up to 3% in 2006 and 2% in 2007, but also reported downward revisions to the inflation forecast for 2007 and 2008. According to the SNB, declining oil prices have pushed back inflation and the annual rate is expected to reach just 0.4% in 2007 and 0.9% in 2008. Lower inflation expectations cooled down expectations that the SNB will lift rates much further in 2007, and in the moments following the release of the SNB statement, traders aggressively sold the Swiss franc against the U.S dollar.  Traders are concerned that if we see lower inflation in 2007 as a symptom of slower growth and rising unemployment, the central bank may be tempted to leave interest rates unchanged in order to stimulate the economy. Although the SNB is close to the end of its tightening cycle, in the press conference that followed the announcement of interest rates, SNB President Roth surprised many traders by saying that a rate of 2% was still expansionary, which clearly hints to further tightening in 2007. If the economy performs as the SNB expects, the central bank should continue its strategy of gradual normalization of its interest rates even if inflation remains low.

Unemployment rate close to its lowest levels since October 2002

Economic growth in the Switzerland remains very strong, and even though the rate of economic expansion is expected to become less pronounced in the second part of 2007, the overall economic climate should remain very favorable for the Swiss franc. "The economy is currently in excellent shape and we are pursuing the goal of continuing to ensure long-term price stability", SNB President Jean-Pierre Roth said at a Media News Conference in Zurich. The SNB expects GDP to grow by 3% in 2006 and around 2% in 2007, revised up from 1.8% in their last quarter report. The situation on the labor market also looks very healthy and the unemployment rate is close to its lowest level since 2002. In the last four quarters, the number of employed persons rose by approximately 100,000 and the unemployment rate unexpectedly fell in November to 3.1%, from 3.2% in October. A lower unemployment rate normally leads into more income earning workers and greater consumer spending, but can also spark inflationary pressures which may force the Swiss monetary authorities to increase interest rates which will make holding the franc more attractive to foreign investors and probably result on appreciation of the currency.

SNB Chairman Roth not concerned with the current level of the EUR/CHF exchange rate

In 2006 the euro advanced 473 pips or 2.8% against the Swiss franc, appreciating from 1.5502 in January the 3rd to above 1.60. In contrast to popular belief, at its introductory remarks to the end of year conference in Zurich, Jean-Pierre Roth, the Chairman of the Governing Board of the SNB didn’t sound excessively concerned with the current level of the EUR/CHF exchange rate even though he was a few months ago. The chairman said that the exchange rate is only important to the extent that it influences inflation either directly via the prices of imported goods or indirectly via the business cycle. He also noted that phases of Swiss franc weakness have been historically followed by periods of currency strengthening. Still, he also said that even though volatility of the Swiss franc against the euro has been negligible, financial market players and businesses should be aware of the exchange rate risks they take. These warning comments follow some previous statements by Governor Roth, where he openly criticized some hedge funds that borrow in Switzerland to enter into carry trades in the chase for a quick profit.  For the time being, the weaker Swiss Franc helps to boost trade as well as inflation.  Until the SNB is willing to back action with words and actually do something about the value of the franc (like raise interest rates), the currency could continue to remain weak. 

Conclusion

What the Swiss National Bank does in 2007 will be dependent upon how inflation behaves.  Right now, inflation is low which means that they can be much more relaxed about raising rates.  Another rate hike is expected from the central bank next year, but not a series of aggressive ones.  The additional monetary tightening should provide some support to the franc against the U.S. dollar since the Federal Reserve is widely expected to start cutting interest rates in the second half of 2007. However, the franc could fall further against the euro, since the European Central Bank is expected to increase rates at a faster pace than the SNB, and the widening interest rate differential between the Eurozone and the Swiss economy should encourage short term investors to invest in assets outside the country. Still, the depreciation of the franc against the euro should make the Swiss exports more competitive and the currency inflows generated by the trade surplus could place some upward pressure on the value of the EUR/CHF. The Eurozone is Switzerland's biggest market and the depreciation of the EUR/CHF in the last quarter of 2006 helped Swiss exports to reach a record 16.6 billion francs in October The remarkably improvement of the economic condition in Europe should continue to help Switzerland to achieve sustainable growth and employment.
Technical Outlook

The USDCHF looks similar to the inverse of the GBPUSD.  That is, there is divergence (but bullish) on the weekly chart with RSI at the recent extreme (1.1878).  Initial resistance is at 1.2346, which is followed by a resisting trendline drawn off of the March and October highs.  That line is at 1.2640 this week (this is the week ending December 15th) but decreases about 20 pips per week.  The overlapping and corrective nature of the rally from 1.1283 to 1.3284 and the decline from 1.3284 to 1.1878 suggests that the USDCHF could be in a triangle (bold lines).  If this is the case, then trading may continue in a choppy fashion as the pair makes its way towards the resistance line from the triangle in the coming months.  Alternating legs of a triangle are often equal to each other by a Fibonacci ratio.  In this case, 61.8% of the 1.1283-1.3284 leg would place the end of this leg above triangle resistance, but a 50% relationship suggests an end to this latest bounce (if 1.1878 holds) at 1.2879. 

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