For many foreign exchange traders, the US Treasury’s decision to designate Switzerland as a currency manipulator last month comes nearly six years too late and with a good dose of irony.
The Swiss National Bank threw currency markets into full-blown chaos in January 2015 when it unexpectedly abandoned its cap on the franc’s value, within days of a senior official reiterating the central bank’s commitment to keeping the mechanism in place. Banks and investors suffered large losses, brokerages went bust and legal disputes rattled on for years because of the shock decision.
To be fair to the SNB, it had no choice but to hold the line right up to the point where it dropped the policy.
In private though, senior industry figures were fuming and many argued that the move was the very definition of currency manipulation. They believed that by promising to keep the so-called exchange-rate floor in place, the central bank allowed the build-up of large bets that the euro would not weaken below CHF1.20 ($1.37). When the SNB stepped back, the euro collapsed as investors rushed to liquidate their bets, causing the franc to rocket nearly 40% higher.
And yet, the US Treasury in its report three months later struck an understanding tone and refrained from putting the Alpine nation on the equivalent of the central bankers’ naughty step.
However, last year, when the Swiss central bank was forced to step in to currency markets to stop the franc appreciating as investors flocked to safety from the pandemic-induced ructions in financial markets, it triggered a stern response from the outgoing Trump administration: it was officially labelled as an exchange-rate manipulator.
As the US Federal Reserve flooded the world with trillions of dollars, an estimated $98 billion intervention in currency markets by Swiss policymakers proved too much for Treasury officials.
“By the narrow confines of the Treasury’s criteria, Switzerland has been held bang to rights. However, the criteria list and the case for the prosecution have more holes in them than a block of Emmental,” said David Oxley, a senior Europe economist at Capital Economics.
Oxley noted the Treasury itself acknowledged that the growth in Switzerland’s trade surplus with the US this year — one of the three criteria that triggered the designation — was mainly due to US purchases of Swiss gold. The report also did not take into account the services sector, where the US enjoys a significant surplus.
But it was the SNB’s decision to intervene in the franc that was the clincher. Currency intervention carries a certain stigma because central banks have agreements and commitments to allow their exchange rates to be market-driven. Policymakers usually only resort to direct foreign exchange action when all other options, such as cutting key rates, have been exhausted.
Switzerland has long moved beyond caring about niceties, because it has run out of other policy tools. Its key rate is the most negative among the G10 countries at minus 0.75%, its domestic bond market is relatively small and in times of stress the safe-haven franc surges.
In the post-pandemic policy environment, some major central banks might face uncomfortable choices too. The flood of money unleashed by the Fed has put the dollar under pressure over the past year and pushed the euro nearly 10% higher than at the start of 2020, causing a growing headache for the ECB.
So it is hardly surprising that on the very day the Treasury announced its decision, the SNB said it “remains willing to intervene more strongly in the foreign exchange market”.
It has to. Even after the strong rally in risk assets in 2020, the franc is nearly 10% stronger against the euro than during the five years of the currency floor. The dollar, meanwhile, has faced significant losses over the past year, shedding more than 7% of its value against a basket of its peers. Against the Swiss franc, the dollar lost around 9% of its value in 2020.
Few analysts expect a meaningful follow-through from the US Treasury. President-elect Joe Biden is expected to take a less confrontational approach to trade than his predecessor. And analysts believe the Swiss franc is unlikely to change direction as result of the label by the US.
“The designation is doubly insulting to the SNB because if Swiss policymakers were trying to gain a competitive advantage, they are clearly not doing a very good job!” Oxley said.
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