Currency wars are here, argue Audrey Childe-Freeman and Cesar Perez of JPM Private Bank
At a time when prospects for the world economy have deteriorated significantly and with policy makers running out of ammunition, currency trends have become increasingly important. In fact, it may be argued that we have re-entered a ‘currency war zone’ write Audrey Childe-Freeman and Cesar Perez (pictured)
The Swiss economy is a small, open, export-orientated economy and so not surprisingly, currency trends matter.
Chemicals (49%) and machinery equipment/electronics (22%) represent the bulk of the export sector. It is also important to note that the aggregated European bloc (i.e including the UK) represents 59% of total Swiss exports.
In this respect, it is not really surprising that the SNB puts so much emphasis on the EUR/CHF cross.
In spite of the continued Swiss franc appreciation throughout H1 (CHF was up nearly 6% versus the EUR over the January-June period), the Swiss export sector proved remarkably resilient earlier this year. This was related to an impressive economic environment in Switzerland’s main trading partner, Germany. However, with Germany (and the rest of Europe) and the US going through a sharper slowdown in H2, it seems obvious that the risk to Switzerland’s export sector has become strongly tilted to the downside.
Swiss economic growth has been solid so far this year, with Q1 GDP growth expanding at a reasonable 2.4% yearly rate. However, the most recent forward looking and reliable economic indicators (such as the KOF index) point to worse times ahead. The Expert Group of the Confederation now assumes a GDP growth rate of 2.1% for 2011 and just 1.5% for 2012. The risk is tilted to the downside. While domestic demand (and the construction sector in particular) remains strong at this point, weakening external demand will have negative spill-over effects on the manufacturing sector and eventually on employment growth.
At a micro level, the appreciating Swiss franc has had a pronounced effect on the revenues and profits of Swiss companies. These companies are highly exposed to two types of risk. The first is a transactional currency risk where a large portion of a company’s revenues are generated outside of Switzerland against a domestic cost base. Transactional currency risk also affects profit margins as revenues are denominated in a depreciating currency (against Swiss francs) whilst the cost base is unchanged. The second form of currency risk is translational currency risk as most companies report earnings in Swiss francs.
The strong Swiss franc has had a large impact on both medium and large sized companies. Earnings of SGS, a medium sized testing and inspections company, were significantly impacted over H1.
Of the large Swiss based companies, Roche was also notably impacted given a high proportion of its sales generated from the US. Market estimates are for the impact on Roche’s earnings for the full year to be significant, with a 10% profit growth target in local currencies translating to a flat profit profile in Swiss francs. So both SGS and Roche suffered from transactional and translational risks.
In fact, the currency impact on profits was greater than the impact on revenues, which implies that margins have been squeezed.