Why did investors suddenly turn away from the currency, which has gained in power in recent years? From July 24, the Swiss franc (CHF) has been the weakest currency in the world among 31 developed and emerging economies, writes Marcin Lipka, senior analyst at Conotoxia.com.
In recent days, the franc has incurred significant losses: 4 percent in the relation to the euro or to the zloty, and 5 percent to the forint. What are the reasons for the downward trend and is it the end of the markdown?
Peculiar position
The Swiss currency has been known for years as a "safe haven," and this term was driven from the strong economic position of the Alpine country, seen mainly through the current account balance. Every year, the Swiss economy has practically surpassed the excess of goods, services and balance of foreign investment.
Over the last 20 years, this excess has averaged about 10 percent of GDP per year, on the one hand, meaning the highest levels in the world, and on the other, the constant, fundamental advantage of the demand for the franc over its supply.
The past two decades, however, has consisted not only of the rise of the Swiss currency itself. At the beginning of the current millennium, the 6-year trend of the weak franc has ended, during those years the CHF had lost as much as 40 percent of the dollar value, and in mid-2001 it cost only 2.2 zł.
The second, already widely known, trend of weakening the franc had coincided with the outflow of loans denominated in Swiss currency and brought CHF from over 3 zł to 2 zł. However, as the surplus on Switzerland's current account had been still very high at that time, the conclusion is, that other factors have influenced the currency more than the trade or profits of the foreign companies.
Flow of the capital depends on the economic climate
Since the current account balance has not fully explained the behaviour of the currency, it is worth paying attention to the financial flows. Profits earned by Swiss companies, either return home or have been reinvested abroad. The latter case occurs when the global economic climate is relatively good. That is why, in the years 1996-2001 and 2004-2008, the franc had been weakening - the earlier accumulated capital has flowed from the country.
After the global financial crisis from the end of the past decade, to earlier flows of Swiss capital have joined the concerns about the condition of the eurozone. For several years, not only the Swiss foreign investment has been reduced, but also foreign capital (also speculative) has flowed. This element has become the substantive reason for the resignation of the SNB from keeping the EUR/CHF constant exchange rate - in mid-January 2015.
However, the SNB has not capitalized completely. Monetary authorities have decided to lower interest rates to minus 0.75 percent to discourage the purchase of the franc. Exchange rate interventions on a massive scale have continued to be sustained, reducing the upward pressure on the CHF.
Over the past seven years, Switzerland's currency reserves have increased by more than 600 billion francs (from 100 to 720 billion). In the same period, a current account increase of 450 billion francs had been generated. As a result, the assets acquired by SNB abroad (bonds and shares) have decreased not only a positive current account but also at least a part of the inflow of foreign capital.
Nobody wants the franc now?
The combination of currency interventions with negative interest rates in Switzerland and the diminishing threat of more serious problems in the eurozone after the French election has contributed to the weakening of the franc at the end of the back of the year.
In the past two weeks, the sharp decline in the CHF course has, however, been a result of growing fear. The capital accumulated in francs has clearly begun to lose value. There is a situation that has been evolving, in which investors investing in Swiss currency have not only suffered losses at a negative interest rate, but their asset value has become lower due to the weaker franc.
As a result, this has led to panic, which overestimated the franc by more than 4 percent in less than two weeks. Current trends may also include more willingness to sell francs and investments outside of Switzerland by local businesses. They may also be afraid that with the continued weakening of CHF, the future foreign investment will become more expensive.
The current trend can also be enforced by the behaviour of wallet capital. Larger investors may, at some point, consider the franc to be weaker than it has been today. In connection with the maintenance of negative interest rates, this may be a support the carry trade strategy, in which borrowed and exchanged local francs will be invested in Treasury bonds in emerging countries. The consequence of this approach may lead to a further reduction in CHF value.
Maintaining the current trend and increasing the popularity of the carry trade financed in francs may lead to a scenario in which the Swiss currency will change its status from a "safe haven", offering capital protection, to a hot potato that no one wants to keep on account of expected losses. It could also lead to the situation, that the franc in relation to the zloty will be quoted in the next quarters closer to the boundary of 3 PLN than 4 PLN.