Will the Swiss franc rally into late summer?
Over the past few weeks, the Swiss franc has maintained its strength against the euro, while easing somewhat against the US dollar. In our view, the currency’s recent strength is largely due to a combination of softening US inflation prints and the ongoing slowdown in euro area growth. Year-to-date, the Swiss currency is up 4% against the euro and 7% against the US dollar.
We think that the recent rally in the Swiss franc is unlikely to extend into late summer. While the Swiss economy has held up relatively well in the first half of 2023, recent data shows that the export-oriented country is finding it increasingly difficult to shield itself from the economic slowdown beyond its borders. Switzerland’s manufacturing PMI came in at 38.7 for July – its lowest reading since April 2009 and even lower than the euro area. What’s more, Swiss exports slumped in July, confirming the current weakness in Swiss activity. Unemployment has started to creep up from very low levels, suggesting that Switzerland’s tight labour market has started to ease. Switzerland’s weak macro momentum is putting its currency at a disadvantage, especially against the dollar, given the resilience of US activity. However, the franc should hold up comparatively well against the euro, which is likely to face increasing headwinds from China going forward.
Switzerland’s current macro backdrop also suggests that there will be less urgency for the SNB to raise its policy rate to 2% from the current 1.75% at the upcoming September meeting. Nevertheless, we do not expect the pronounced Swiss yield disadvantage to disappear any time soon. As we recently discussed, global yield dynamics are particularly important for the USD-CHF pair and have a much smaller impact on EUR-CHF. Indeed, our near-term fair value model for USD-CHF indicates that the valuation gap has widened significantly in recent months, while EUR-CHF is more in line with what our near-term model suggests given current yield and volatility levels. Moreover, continued uncertainty about the Fed's rate path should keep bond volatility high in the near term. In our view, this will support the Swiss franc against the euro in the coming months. However, this may not matter for USD-CHF, so the pair could move higher in the near term.
The longer-term picture for the Swiss franc remains unchanged, largely reflecting the differences in inflation dynamics between Switzerland and the rest of the world. In essence, Swiss inflation should remain significantly lower than in other developed economies for most of next year, which can be attributed to several factors. The share of administered prices carry a relatively large weight in Switzerland and the appreciation of the Swiss franc helps to shield the domestic economy from higher import prices. Perhaps most importantly, Switzerland’s moderate wage growth is keeping the risk of a wage-price spiral relatively contained compared with other economies. In real terms, the Swiss currency remains very close to its long-term trend, despite some recent appreciation. Over the long term, we expect Switzerland’s inflation advantage to continue to support the nominal appreciation of its currency against both the euro and the US dollar.
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