The effectiveness of central bank intervention in the foreign exchange markets has long been debated.  In general the activity can be effective in the short run, but in the long run it is the supply and demand fundamentals that determine a currency’s value.In August of 2011 the Swiss National Bank (SNB)intervened on a massive scale.  The stated goal of the central bank was to keep the EUR/CHF exchange rate above 1.20.  The floor has now held for six months, but market conditions and leadership changes at the SNB have us all asking whether or not this level will hold up in the long-term.  To provide context for the analysis of the SNB’s intervention activities, we first examine the efforts and effectiveness of intervention attempts by the Bank of Japan and Reserve Bank of New Zealand.

Tyler J. Lynch, CFA, Director, Foreign Exchange Sales, BMO Capital Markets

The Bank of Japan (BoJ) has intervened in the foreign exchange markets to influence the value of yen on hundreds of occasions in the last 20 years.  The daily value of their intervention exceeded US $1 billion on no less than 150 days since 1991.  The result of each instance has been the same; the efforts of Japan’s central bank may have slowed the pace of appreciation or even reversed the trend for a short period of time, but inevitably the market’s appetite for yen led to further appreciation.During the last decade the Japanese yen has appreciated by 70% against the US dollar.

The most significant level of activity from the BoJ occurred in the first quarter of 2004 when they spent US $148 billion to limit the yen’s strength.  This was the equivalent of 3.2% of Japan’s GDP.  During that period the yen actually appreciated by nearly 3% against the US dollar (from 107.22 to 104.23).  The pair did rise as high as 112.34 in February of 2004.  Interestingly theBoJ spent twice as much in January than they did in February.
(See Graph # 1)

New Zealand’s central bank intervened in June of 2007 when NZD/USD reached a 22-year high of 0.7640.  The effort lacked conviction and the currency pair topped 0.80 by the end of July.  According to the Reserve Bank of New Zealand (RBNZ),currency intervention activity totalled NZD 2.2 bn (US $1.7bn) in June and July of 2007, which equates to just over 1% of New Zealand’s GDP.   After a short lived sell-off in mid-2007, the New Zealand dollar surged higher, peaking at 0.8200 in early 2008.  From February to May of 2008 the RBNZ spent another NZD 1.6 bn (US $1.3 bn) to stem the currency’s strength.  Over the next 12 months NZD/USD fell by40% to below 0.5000.  This move was not a result of effective intervention, but rather it was a result of the onset of the global financial crisis.
(See Graph # 2)

In March of 2009 theSwiss National Bank intervened in the foreign exchange markets for the first time since 1995 when EUR/CHF fell below 1.46.  Their efforts pushed the pair to as high as 1.5447 in just three days; a move that included a 5+ big figure rise on March 12th alone.  The SNB’s currency assets increased by 20% from CHF 46.5 billion to CHF 55.8 billion during thatround of intervention.  They continued to defend the 1.50 level for the next several months and by the end of June the SNB had increased their currency holdings to CHF 81.7 billion francs (US $75 billion).  EUR/CHF breached the 1.50 level in December of 2009 prompting the SNB to spend an additional CHF 30 billion in February and March of 2010, but they could not prevent the pair from breaking below 1.46.  Over the next two months the SNB increased their foreign currency holdings byCHF 113 billion (US $106 billion).  To put this in context, the activities of the BoJ and RBNZ were in the 1-3% range when measured as a percentage of GDP.  US $106 billion is 20% of Switzerland’s GDP.Despite the magnitude of this activity EUR/CHF made new lows in June and continued to trend lower until August of 2011 when the SNB unleashed another round of intervention.  The central bank increased foreign currency holdings by another CHF 116.5 billion (US $135 billion) in August and September.  By September 6th the pair was trading over 1.20 after trading below 1.01 on August 9th.  The 1.20 level has held and foreign currency assets owned by the SNB have declined since September (from CHF 305 billion to CHF 257 billion).
(See graph # 3)

Part of the SNB’s apparent success may have had more to do with timing than anything else.  The markets response to the ECB’s LTRO and a resolution (I use this term loosely) to the Greek debt crisis in mid-February provided a lift to the euro, which has taken some of the burden off of the SNB.Rising equity and commodity prices over the past several months suggest that market participants are feeling more comfortable holding risky assets.  This is also good news for the SNB as “safe haven” flows were a large contributing factor to the franc’s strength over the last several years.

Will the SNB continue to defend the 1.20 level?  In a recent interview with the Financial Times, Thomas Jordan, the acting chairman of the Swiss National Bank said “We will enforce this minimum rate with the utmost determination and we are prepared to buy foreign currency in unlimited quantities if necessary.”  The SNB has certainly demonstrated a willingness to defend the 1.20 level, but they’re ability to intervene may be at risk.  A special session in parliament this spring could affect the independence of the SNB.  Expressing concern, Mr. Jordan said, “There are proposals to limit the instruments which can be used by the SNB, such as limiting the size of the balance sheet or foreign exchange interventions.”

Whether or not the SNB continues to intervene, the importance of having a sound foreign exchange risk management policy remains the same.

Clients of BMO Capital Markets count on us to help them establish and execute their foreign exchange risk management strategies.  To learn how BMO Capital Markets can help you achieve your ambitions, email us [email protected], or visit www.bmocm.com/fx for a list of contacts in your area.

Sources:

1. Tett, Gillian and Gapper, John, February 2, 2012, “Jordan vow to continue SNB intervention”,Financial Times.
2. Swiss National Bank – Monthly Statistical Bulletin February 2012
3. Reserve Bank of New Zealand
4. Japanese Ministry of Finance

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