EconomicReason

At 1.64 CHF per Euro, the Swiss franc trades at a new multi-year low (see also my recent post).

The reasons are low Swiss interest rates, low perceived exchange rate risk and a high international risk appetite, all of which encourage speculators of all kinds to use the Swiss Franc as a cheap funding currency, above all hedge funds using the Swiss franc as a funding currency in carry trades, but also individuals and firms, mostly in Eastern European countries, taking out Swiss franc denominated loans. The Swiss Franc has become a source of global liquidity, similar to the Japanese Yen, however, on a smaller scale.

The EURCHF chart below shows signs of going parabolic and looks suspiciously like a speculative bubble. The situation is an accident waiting to happen. Unlike Japan, Switzerland is a small open economy. The Swiss Franc is probably significantly undervalued by now. The inevitable correction with an overshooting in the other direction will result in a sizeable appreciation against the Euro, which will be the demise of many exporting firms in Switzerland, house owners in Eastern Europe, and certainly the current phase of economic expansion in Switzerland.

Monetary policy, as the guardian of all prices, including exchange rates, can and should act to prevent the build-up of such bubbles, be it in asset prices or exchange rates. However, inflation targeting does not allow for such action. This is the reason why, in a few years, inflation targeting will be relegated to where it belongs, namely, to the ash heap of history. However, we are not there yet. Central banks learn slowly. That’s why speculation will pay for many more years to come.