Challenges for investors, not for business

Inflation rates are currently much lower in Switzerland than abroad. That’s helping companies to cope with the rising value of the Swiss franc, but this appreciation is proving challenging for investors.

The pace of economic developments has accelerated during the coronavirus crisis. The downturn happened at unprecedented speed, and the recovery was also extremely rapid – so fast that an overheated economy is now causing prices to soar worldwide.

But prices have risen much less sharply in Switzerland than abroad. This difference is also reflected in the Swiss franc exchange rate. We’re all used to it: every currency falls in value against the Swiss franc over time. The US dollar once cost 4 francs, whereas today it’s less than 1. The euro cost over 1.60 francs before the financial crisis, while today 1 euro is almost equivalent in value to 1 franc.

Inflation rates are a clear indication of how much a currency is losing in terms of purchasing power.

A strong franc is relative...

Switzerland’s lower inflation rate lies behind these developments. Inflation rates are a clear indication of how much a currency is losing in terms of purchasing power. If the inflation rate in Switzerland stands at 1 percent, this means that 1 percent less can be bought with 1 Swiss franc than in the previous year. But if the purchasing power of other currencies falls more quickly than that of the Swiss franc, then their value declines against the franc. In other words: the “fair exchange rate” falls.

And that’s exactly what’s happened recently. The best approach is to look at the prices of goods leaving a factory – they’re highly negotiable. In Germany, these prices have recently soared by 14 percent year-on-year, but in Switzerland, they have risen by just 5 percent. This is due to the fact that input prices in Germany – e.g. energy – have increased much more sharply. The strength of the Swiss franc – as we’ve seen recently – is relative. A company receives less for its products if it can no longer sell them at 1.15 francs, as was the case over two years ago, but instead only at 1.05 francs. But it also has much lower input costs than its competitors abroad, which means that it’s not in a worse position overall.

...but presents challenges for Swiss investors

Swiss investors face a more challenging situation, however. Return earned abroad may look higher – but if that’s only due to higher inflation rates in those countries, it’s offset by currency losses. It’s important for Swiss investors to measure return generated abroad in Swiss francs. That’s also why the optimal domestic market allocation is much higher for Swiss investors than those abroad.

Due to the major differences in inflation at the moment, the probability of the Swiss franc continuing to appreciate is high – albeit at a steady rate, thanks to the Swiss National Bank’s interventions. For this reason, focusing on other currencies does not seem tactically opportune at present.

About Daniel Mewes

Daniel Mewes has worked at PostFinance for 18 years and is currently Chief Investment Officer and Head of Asset Management Solutions. The Bern native studied Business Administration at the University of Bern and is a qualified financial and investment expert holding an EMBA from the University of Applied Sciences in Business Administration Zurich and the Darden School of Business at the University of Virginia.

 

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