Last week again saw a high level of risk aversion, resulting in a sharp drop in the euro against the safe haven currencies of the Swiss franc (CHF), Japanese yen (JPY) and US dollar (USD). The uncertainty surrounding the length of the lockdown period (some studies point to restrictions on the movement of people until the summer in the United States) and the run of poor economic data prompted caution.
The best indicator of the extent to which the present period is unparalleled in modern history is the figure for weekly unemployment benefit claims in the United States, which reached a record 6.6 million in the week to 28 March, compared with 3.7 million one week earlier. This level is completely without historical precedent. The previous record for a non-coronavirus period was set in 1982, with a figure of 695,000, at a time when the United States had gone into recession as a result of the US Federal Reserve’s restrictive monetary policy. Weekly claims in California alone (872,000) exceeded the 1982 record.
As we pointed out last week, risk aversion is expected to reign supreme over the currency markets for as long as the barrage of poor indicators lasts, as reflected in a sustained decline in the euro.
Further bearish momentum for EUR/USD
The euro temporarily moved higher against the dollar at the start of last week after the Fed introduced new dollar swap lines for a larger panel of central banks. This is the third such operation since 15 March and gives non-US financial players such as Asian banks continued access to low-cost dollar (USD) refinancing. The abundance of dollars in the international monetary system led to a temporary fall in the US currency.
This was reflected in a high last week for the EUR/USD pair of 1.1170. The downward trend quickly regained the upper hand, however, partly due to resurgent political risk in the eurozone. The deep divides between the north and the south of the eurozone on the mechanisms to be adopted to provide a coordinated response to the crisis in budgetary terms pushed the euro towards 1.08.
The next test for the single currency will be the Eurogroup meeting of finance ministers from the eurozone scheduled for Tuesday evening. The roadmap established by the European Council (heads of state and government) is clear: solutions are needed. There is still profound disagreement, however, and, as is often the case in Europe, the final deal that could be struck may be minimal. Add in the continued deterioration of economic indicators in Europe and you have the perfect ingredients for the euro to continue its descent towards 1.06-1.05 in the next few weeks.
The Swiss franc (CHF) is no longer a safe haven
In contrast, the euro’s decline against the Swiss franc has been more modest since the start of the year (-2.8%) as a result of massive intervention in the currency market by the Swiss National Bank (SNB). The chart below shows the change in banks’ overnight deposits with the SNB, which act as a barometer for assessing the level of intervention.
The latest available data show that the SNB had to purchase the foreign currency equivalent of nearly 10 billion francs in one week to limit the appreciation of the CHF. This is the highest level since the start of 2015, when market pressure compelled the SNB to abandon the price floor of 1.20 for the EUR/CHF. The central bank is expected to maintain a high level of activity over the next few weeks, making as much use as necessary of the weapon of currency intervention to safeguard a level of 1.05 for the EUR/CHF. The expansionary nature of the bank’s existing monetary policy means that the other weapons in its arsenal, which include decreasing rates, are ineffective.
For the moment, there is nothing to indicate that the SNB will lose its tussle with the market as it did in 2015. It is clear, however, that the longer the mood of risk aversion lasts, the more difficult it will be for the bank to take effective action on exchange rates.
- Bank overnight deposits with the BNS (an increase reflects an upsurge in currency market intervention), lhs
- EUR/CHF, rhs
This article is not intended as professional investment advice.