by Chris Becker
The so-called stability of the Swiss banking system, and the market’s faith in central banks, was shocked to the core last night as the SNB removed its long held peg against the Euro.
What happened next on FX markets was epic – the Swiss Franc appreciated immediately against Euro by approx. 25% and other majors like USD,Pound and Aussie, and have stayed there in the main after several hours of shocked FX traders (lots of blood on the floor there). I’ll go over the volatility in my Macro Morning piece a bit later.
You really can’t call this a Black Swan because it had to happen one day. The SNB could not go on forever buying Euro to stabilise its domestic economy as the flailing union currency depreciated further and further as the EZ economy slips into deflation.
Here are the Bloomberg notes on the lead up to the peg and unpeg to get you up to speed:
- In 2011, during the scariest times for the euro zone, the country’s safe-haven status turned the nation into an island of tranquility.
- Of course, with everyone wanting to have their money in Switzerland, the franc exploded in value.
- In early 2010 one franc was less than 0.7 euro. By the middle of 2011 the franc was nearly at parity against the euro, a massive move in a very short period.
- So in the summer of 2011, the Swiss National Bank announced a cap on the exchange rate between the euro and the franc: 1.20
- The bank maintained the cap by printing francs on a regular basis to buy euros in the market to ensure that the currencies wouldn’t breach that line
So why remove the peg now? Well there are a couple of explanations not only including the forthcoming ECB meeting on the 22nd this month where almost everyone is expecting a large form of QE to emanate from Brussells.
First, heres the official explanation for the removal of the peg by the SNB (emphasis added):
“The minimum exchange rate was introduced during a period of exceptional overvaluation of the Swiss franc and an extremely high level of uncertainty on the financial markets. This exceptional and temporary measure protected the Swiss economy from serious harm. While the Swiss franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate.
The economy was able to take advantage of this phase to adjust to the new situation. Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced. The euro has depreciated considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar.
In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.”
In addition to this huge move, the SNB cut their negative on sight deposit rates further to a nominal -0.75%!
The build up of reserves since the peg has resulted in significant profits for the SNB (which a lot of cantons rely upon for revenue). More from JPMorgan (via FT Alphaville):
The timing of the move may have had part to do with the release last week of the SNB’s massive profits for 2014 (CHF 38bn) which provide a sizeable cushion against the mark-to-market losses the SNB will suffer on its reserve portfolio (the SNB would have been bankrupted by this de-pegging had it not made such a large profit last year).
Most surprising in today’s decision is that the SNB has not chosen to retreat in a managed fashion – it has completely removed the floor such that EUR/CHF is now free floating. This is the cleanest option for the SNB – all ties to ECB policy can now be cut – but also the one with the greatest risk of triggering an undershoot in EUR/CHF from fair-value (which we put around 1.10) as it forces an accelerated unwind of non-resident franc funding (probably in the region of CHF 150-175bn).
Indeed, it is surprising (understatement of the year). A managed peg would have calmed markets a lot more by giving institutions the clear nudge to start unwinding Swissie longs. There is a lot of pain out there in hedge fund (and unhedged retail FX trader) land.
The SNB move cannot be relegated to just preparing for a Euro crash or a post-Euro EZ breakup (German Mark anyone), as it may be repositoning due to USD strength (and hence the pegged Yuan).
For Australian investors this move has truly let the volatility genie out of the bottle as the ramifications about central bank confidence, the trajectory of the Euro and EZ itself, shakeup the risk markets around the world. It also removes any notion that the RBA would consider a peg or any type of market intervention, at least within officialdom.
What a wonderful start to the year!