Why the era of one-way Swiss franc appreciation is over

Here at UBP, we think that the Swiss franc’s decade-long period of outperformance has come to an end; investors would be well advised to prepare for a period of weaker Swiss franc exchange rates.

Over the last decade, the Swiss franc has enjoyed a near constant appreciation trend. The EUR/CHF exchange rate gives the best example of this, falling from levels of around 1.25 in 2013 to around 0.95 by 2022. The franc’s outperformance was explained by a positive real rate spread compared with the euro, and by frequent bouts of risk aversion. Even the Swiss National Bank’s (SNB) negative deposit rate did not deter investors from maintaining franc-denominated deposits, because the franc’s nominal outperformance against the single currency more than offset these negative deposit rates.

The scale of capital inflows into the franc resulted in the SNB intervening to prevent the franc from appreciating too much, resulting in the build-up of a huge FX reserve profile. At one point, the SNB’s FX reserves rose to over USD 1 trillion, although this has since declined to around USD 850 billion. In a bid for greater transparency, since 2021 the SNB has published its quarterly FX transaction data. The latest data show that the SNB was forced to purchase the franc last year to prevent it from weakening too quickly. The change in FX interventions is important for two reasons: first, it shows that the franc is no longer under one-sided appreciation pressure; second, it shows that investors are no longer piling into franc-denominated deposits as before, and there are good reasons for this.

Rising inflation pressures in both the US and the eurozone have resulted in both the Federal Reserve and the European Central Bank raising interest rates aggressively. Consequently, bond yields in the US and the eurozone have steepened significantly. Two-year bond yields in the US and the eurozone now trade at 4.90% and 3.20%, respectively. This gives a huge premium above equivalent Swiss bonds, which trade at levels of just 1.35%. The huge rise in external rates of return implies that investors now have an increasing incentive to allocate deposits towards the likes of the euro and the dollar rather than the franc. The significant rise in core inflation pressures in both the eurozone and the US implies that interest rates will remain at current or even higher levels for an extended period of time. The corollary of this is that investors will increase allocations towards currencies with higher yields, and in this respect, the euro should increasingly outperform against the franc.

The return of inflation pressures and the rise in nominal yields in both developed and emerging markets has led to a resurgence of interest in carry trades. These involve investors selling low-yielding currencies, such as the franc, and purchasing higher-yielding currencies to take advantage of the interest rate differential. Given that Swiss inflation pressures are set to moderate over the coming year, this will lead investors to increasingly use the franc as a funding currency once again. The SNB’s intervention policy, which seeks to limit the franc’s volatility, will aid this process considerably, because investors will not experience severe bouts of funding currency volatility.

The conclusion to draw from these developments is that the long period of one-way franc appreciation has now come to an end. In the immediate future, the euro will outperform against the franc, and investors will increasingly use the franc as a funding currency. These developments will serve to weaken the franc on a nominal basis in the coming quarters.

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