- Dollar falls back as Fed catches up with emergency demandÂ
- Swiss franc remains near 4-3/4 year high against euro on safe-haven demand despite SNB intervention
- March U.S. economic data expected to be brutalÂ
Dollar falls back as Fed catches up with emergency demand — The dollar index in mid-March spiked up to a 3-year high but has since settled back to a 2-week low on Tuesday. Still, the dollar index is up +2.6% on a year-to-date basis as the dollar sees continued demand for dollar-based liquidity.
The dollar index initially fell in late February and early March when the coronavirus first emerged as a major problem for the U.S. since there were dovish implications for the Fed. The Fed in fact made its first interest rate cut of -50 bp on March 3. However, the dollar index then spiked higher in mid-March when the global economic shutdowns began and the global stock markets went into a near melt-down mode. At that point, fears started to emerge about an all-out global financial crisis, which caused global banks, investors, and corporations to scramble for liquidity in the world’s reserve currency.
The Fed then responded to the pandemic crisis with an impressive show of force that has so far succeeded in dampening the crisis environment and getting the markets to settle down. The Fed also blasted dollar liquidity overseas with new and expanded dollar swap lines with all major central banks, thus satisfying the emergency demand for dollars. The Fed also set up a Treasury repo facility for foreign central banks to allow them to borrow dollars against their Treasury security holdings. The dollar in the past several weeks has therefore settled back on improved liquidity.
Where the dollar goes next may depend mostly on whether the pandemic improves (dollar negative) or worsens (dollar positive), and whether the U.S. sees a more severe outcome than other countries (dollar negative).
Swiss franc remains near 4-3/4 year high against euro on safe-haven demand despite SNB intervention — The Swiss franc has been strengthening against the euro since 2018 mainly because of (1) monetary policy differences, and (2) low confidence in Europe due to political populism, instability in highly-indebted members such as Italy, and Brexit risks. Against the U.S. dollar, the Swiss franc has traded mostly sideways in the past several years.
In the past two months, the Swiss franc has received a renewed boost from the coronavirus pandemic, which has caused a surge of investor cash into the Swiss franc due to its long history as a safe-haven asset. The franc posted a 4-3/4 year high against the euro on March 20.
The Swiss franc has an almost mystical quality as a safe-haven asset partially because of Switzerland’s history as a neutral country and its ability to survive numerous crises and wars over the decades. The country also enjoys investor respect due to its resilient economy and low national debt. The country’s central bank, the Swiss National Bank (SNB), is also respected for its dedication to pursuing low inflation. Switzerland’s status as the hub for the world’s gold industry also contributes to its perception of strength and stability.
However, the latest strength in the Swiss franc on pandemic-related safe-haven buying has caused a big problem for the Swiss authorities. The strong franc has hurt the Swiss economy by reducing the competitiveness of Swiss exports just when the country needs stimulus.
The SNB believes that safe-haven buying has caused the Swiss franc to be overvalued relative to its underlying fundamentals. The SNB has therefore been intervening heavily against the Swiss franc in recent weeks. The SNB’s intervention last week was estimated at about CHF 6.9 billion ($7 billion).
The SNB at its last quarterly assessment on March 19 left its policy rate unchanged at -0.75%, but the SNB indicated that it has been intervening “more strongly” in the currency markets against the franc. If that intervention doesn’t work in curbing the franc’s strength, then the SNB has other last-resort options such as cutting interest rates another notch or even restarting a QE program. The SNB’s policy rate of -0.75% is already very low, and the SNB would prefer not to cut the rate further because that would impinge on bank profitability at a time when banks need all the strength they can get. However, there is still the possibility that the SNB could bring out its big guns and either cut interest rates or start a QE program, thus driving the franc lower.
While the SNB has a long history of battling a strong franc, the SNB in 2015 shocked the markets by giving up on its euro-pegging policy and allowing the franc to sharply appreciate. That decision resulted in massive losses by some currency speculators who believed that the franc would not appreciate simply because the SNB said it wouldn’t. Instead, market forces finally won out and the franc spiked massively higher, illustrating the danger of shorting the franc and relying on the SNB to successfully curb the franc’s strength.
The franc’s near-term situation depends heavily on the course of the pandemic. If the worst of the pandemic has already been seen, and if the Fed and other central banks have already prevented a global financial crisis, then the franc could drift lower as safe-haven demand eases. However, if the economic fallout from the pandemic worsens and if there is a renewed threat of a global financial crisis, then the franc could easily shoot to new highs on safe-haven demand regardless of SNB intervention.
March U.S. economic data expected to be brutal — Today’s March economic data is expected to be brutal, followed by even worse data in April. The consensus is for today’s March retail sales report to plunge by -8.0% m/m and for manufacturing production to plunge by -4.2% m/m. Today’s Beige Book report from the Fed is likely to have some very negative reporting about economic conditions on the ground.
