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August 1st, 2012

In the second quarter, the Swiss National Bank’s international reserve portfolio grew 54% from CHF237 bln to CHF365 bln, predominantly the result of foreign exchange market intervention. Its holdings of euros, for example, jumped 77% to CHF219.5 bln. But over the same period, the SNB nearly halved its GBP holdings to roughly CHF12.0 bln. After the SNB intervened forcefully in May and June to defend the 1.20 floor for EUR/CHF, markets have been intensely focused on the extent and nature of FX reserve diversification in an effort to gauge the likelihood of the SNB soon forsaking that floor.

In Tuesday’s FX Viewpoint, the G10 FX Strategy team at Bank of America Merrill Lynch Global Research wrote, “The biggest surprise was that the allocation to EUR assets increased from 51% to 60% of the portfolio, the highest it’s been in a year.* What we are interested in is the net purchases in excess of FX appreciation against the CHF to get an understanding of active SNB management.” BoAML then gave three paths for the SNB to consider for EUR holdings. “In Q3, we expect the pressures on the EUR and markets to increase, which will facilitate greater flows into Switzerland, and greater intervention by the SNB. We think the SNB has three potential paths to consider for EUR holdings: it can increase its EUR overweight, retain current levels or reduce them to the historical averages, which we consider the most likely. The second and third options would imply EUR selling of 18-27bn per month in Q3. We recommend positioning for this flow by choosing the least-liquid currencies the SNB has shown a penchant for buying, including the JPY and those in the Other currencies category.”

* The allocations to USD, GBP, JPY and CAD all declined percentage-wise, while the ‘Other’ currency category increased from 3% to 4%. ‘Other’ refers to AUD, SEK, DKK, SGD, KRW.

Economists at UBS Investment Research saw other interesting news in the latest quarterly report on the SNB’s investment structure. “The data suggest that the use of derivatives had been reduced in the SNB’s balance sheet towards the end of H1’12. This is at least what we read into the convergence between the SNB FX reserves statistics excluding derivatives and the respective statistic including derivatives. The latest expansion of their balance sheet has been the result of both increased security holdings but also higher deposit holdings of the SNB with other official institutions such as other central banks, the ECB, the IMF and not least the BIS. In fact, the latter position increased more pronouncedly [46.8%] up to the end of June ’12. The respective figure for security holdings posted gains of only CHF 10.9%. To our understanding the above is one key reason for the increased share of EUR holdings in the SNB’s FX reserve as per the end of Q2 ’12. It thus will be interesting to see whether and to what degree these deposits will a.) be converted into securities and b.) out of the EUR. Whether the latest increase in the SNB’s balance is calling for additional measures on the part of the SNB is a different matter. The most likely change, if anything, is to take on the SNB’s liability side. The most obvious candidate thereby being the position on sight deposits at the SNB.” UBS thus sees no loosening of the SNB’s collar on EUR/CHF. “To our understanding the developments in the SNB’s balance sheets are a clear indication of the SNB’s commitment to the minimum exchange rate in EUR/CHF. For fundamental reasons this is unlikely to change anytime soon.”

Of the sharp nine percentage-point rise in the EUR weighting of the SNB’s foreign exchange reserves, ING Financial Markets Research concluded, “The obvious suggestion is that it cannot recycle its interventions (totalling CHF127bn in May & June alone) fast enough. This is fine for as the 1.20 EUR/CHF floor holds, but undermines the assumed strong diversification bid for GBP & SEK, et cetera in recent months.” Beyond keeping the floor on EUR/CHF at 1.2000, global currency strategists at BMO Capital Markets said SNB buying has another effect. “It acts as a stabilizer to the EUR/USD as it withdraws EUR from the foreign exchange market. This may be one of the reasons why the EUR/USD has not fallen as precipitously given the European debt crisis.”

The Foreign Exchange Research team at Barclays Capital reckons there are further diversifications flows to come. “Adjusting for spot moves over Q2, we estimate that the reserves increased by CHF114bn over Q2 12. Of this amount, CHF96bn corresponded to purchases of EUR (Figure 2) – in other words, 84% of the SNB’s increase in FX reserves over Q2 was EUR purchases. Interestingly, the SNB’s holdings of other currencies jumped from CHF8.85bn at the end of Q1 to CHF11.5bn in Q2, a nearly 50% increase. The ex-swaps measure of the FX reserve allocation suggests that the percentage allocation towards all currencies except EUR and ‘other’ currencies fell in Q2. We cannot directly infer the amount of SNB holdings from the allocations, and the SNB does not report these numbers. However, we do know that FX reserves increased by about 50% in Q2. Given the outsized allocation to a single currency, we think it likely that the SNB continues to try to diversify these holdings over the next few months. In our view, these diversification flows offer the best risk/reward in positioning for our base case outlook of continued EUR weakness and the SNB successfully defending the floor. These flows will be felt the most in EUR/CAD and EUR/GBP, some of which has likely already happened in July. The less liquid ‘other’ currencies (i.e., AUD, SEK, DKK, SGD, KRW) will also be supported by the SNB’s diversification flows, especially if the pace of flows into these currencies remains the same as in Q2.”

In their August 1 FX Strategy Daily, Lloyds Bank Wholesale Banking & Markets spotlighted the SNB’s diversification away from EUR, even if it came at a slower pace. “The SNB undertook around CHF130bn of FX intervention in Q2. Based on the latest breakdown of FX reserves, we estimate that around CHF30bn has been diversified out of EUR, half of which into USD. Surprisingly our estimates suggest that none was into GBP. The sizable increase in EUR holdings suggests there is more EUR diversification to come; but given the moves in EUR crosses last month we would expect some to have been done throughout July.”

The Global Currency Strategy team at Brown Brothers Harriman conjectured, “In recent weeks there has been widespread market talk of the SNB or the BIS, on its suspected behalf, selling euros. There had been some suspicion that it was also partly behind the general resilience of sterling. Sterling’s share of Swiss reserves actually fell to 3% from 5%. The US dollar’s share fell to 22% from 28%. Of note, in addition to the euro, the “other” category was the only other one to show an increase (from 3% to 4%). Although the SNB is known for its conservatism, most central banks do not appear to use emerging market currencies in reserves, especially outside their region. The SNB also holds 10% of its reserves in equities and this appears to be a stable allocation. Few central banks hold equities in reserves.” Similarly suspect, HSBC Global Research remarked, “Markets have regularly speculated that the SNB is recycling (sometimes aggressively) the EUR it continues to accumulate from its EUR/CHF intervention into other currencies, but our London colleagues point out that this data raises some doubt about the extent of such activity.”

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