Will Frankenstein enter the foreign exchange market for Halloween?

If a currency increases in value, it is often the result of economic developments or interest rate movements. Behind the rise of the Swiss franc lies something else. The currency is on the rise as financial parties worry about the eerie phenomenon of stagflation.

The euro has been in the dark of the currency world in recent weeks. The currency is falling against the dollar, because the economic recovery in the European Union is less vigorous than in the United States. And because the European Central Bank (ECB) is pulling the interest rate brake later than the Federal Reserve (Fed). The same goes for the Bank of England. The British pound is hovering around its highest rate, against the euro, in almost two years. The increased prices of oil, natural gas and other energy commodities are pushing up the value of the Australian dollar, Canadian dollar and Russian ruble.

New debt crisis? Rather not!
The Swiss franc is also gaining ground. But why? Switzerland's economy is growing more slowly than in the European Union and the Alpine country does not export oil or other commodities. Many financial parties that now buy francs do so because the country does not import something. Namely inflation. The Swiss National Bank (SNB) takes its inflation target more seriously than the ECB, which prefers not to do anything that jeopardizes economic growth. When the European economy gets into trouble, the differences between the Member States come under a magnifying glass. And a repeat of the European debt crisis is the last thing the ECB wants.

The SNB does not have to take these kinds of political considerations into account and focuses entirely on the inflation target. If global inflation remains high for an extended period of time, the bank may allow the Swiss franc to rise to prevent inflation from spilling over into the economy via currency markets. The SNB often intervenes to prevent the franc from becoming too strong. But lately that has happened less frequently and vigorously than in the first half of the year. However, something needs to happen before the SNB loosens the reins as strongly as in January 2015. Then the bank dropped its peg with the euro overnight. In one fell swoop, the currency shot up 30% against the European currency and 25% against the dollar.

Safe hiding place
Although such a price jump is not obvious, the franc has plenty of room to increase further; as long as concerns about stagflation rule the financial news stream. Stagflation occurs when inflation rises and remains high while economic growth slows. The word has been featured more and more recently in financial articles and economic forecasts for 2022. In addition, the franc is known as a safe haven in periods of heightened uncertainty in financial markets. This makes the currency a good hiding place for those who are concerned about the flaring up of the virus outbreak, about the way in which central banks will withdraw support measures or about the very high optimism in the stock markets.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.