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Swiss Franc Move: What Does It All Mean?

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Rivers of ink and the vastness of the blogosphere have been devoted to explaining Thursday’s shock move by the Swiss National Bank to defend its currency.

Since much of that commentary is not always comprehensible to the foreign-exchange uninitiated, herewith, as a public service for financial advisors, is a brief plain-English account:

What exactly did the Swiss National Bank (SNB) do?

Switzerland’s national bank did two things: ended a three-year-old peg that had set a minimum exchange rate of 1.20 Swiss francs (CHF) to the euro and lowered its interest rates.

Why did the SNB end the peg, and what effect did that have?

In a hastily arranged press conference Thursday, SNB chairman Thomas Jordan said the bank introduced the peg at a time of “exceptional overvaluation” of his nation’s currency.

As a nation dependent on exports, and whose primary market is the European Union, Switzerland introduced the peg in 2011 to defend the viability of its goods and services, by keeping them from being priced too high in euros.

Ending the peg sent the Swiss franc soaring 30%, resulting in a near state of mourning on the part of Swiss industry.

“Words fail me,” Swatch CEO Nick Hayek is quoted as telling the U.K.’s Telegraph. “Today’s SNB action is a tsunami; for the export industry and for tourism, and for the entire country.”

The move also undid foreign exchange broker FXCM, since the volatile currency move caused $225 million in losses from clients positioned in the crowded euro trade. The SNB’s lifting of the peg removed a significant source of demand for euros. Many similarly positioned financial institutions were hurt, albeit to a lesser degree.

Why did the SNB discontinue its euro peg?

To maintain the 1.20 CHF-euro exchange rate, the SNB had to buy increasing quantities of euros as that currency weakened against the franc, causing a ballooning balance sheet.

The key turning point, most commentators have pointed out, was the European Central Bank’s announcement that it would launch a massive quantitative easing program starting next Thursday. That would place significant downward pressure on the value of the euro, multiplying the cost to the relatively small SNB of maintaining the CHF-euro peg. Exiting the exchange-rate peg after the ECB’s move would be even costlier and more painful.

Was the SNB’s Move Foreseeable?

The SNB had defended 1.20 franc-euro parity as a cornerstone of its policy only days earlier.

According to Bloomberg, analyst Jason Shenker of Austin, Texas-based Prestige Economics was alone in forecasting the move, saying:

“Our forecasts have been predicated not necessarily on an exclusive lifting of the ceiling, but rather on the fact that the market direction for the euro and the Swiss franc would be basically unsustainable and indefensible.”

Why did the SNF lower interest rates?

SNB chairman Thomas Jordan said at Thursday’s news conference the rate shift, lowering rates on certain deposits to -0.75% and lowering its three-month Libor target by 50 basis points to a range of -1.25 to -0.25%, was meant to make “Swiss franc investments considerably less attractive” and mitigate the effect of discontinuing its euro peg.

What does all this mean?

While the fallout of the dramatic currency move will likely continue to expand in the coming weeks, currency expert Axel Merk told Bloomberg TV that the resulting jolt, while claiming a few victims like currency trader FXCM, will not be systemic. He added that the SNB effectively removed incentives for businesses to hedge their currency via the Swiss franc and warned of persistent deflationary fears.

Most ominously, Merk said the move demonstrated that central banks can turn on a dime, and he warned that stock and bond markets could see similar sudden and large-scale reversals.

In an interview with ThinkAdvisor earlier in the week, Merk explained his view that stocks would fall, cash — and the dollar in particular — is no haven, and that he “wouldn’t touch bonds with a broomstick.”

— Check out Schwab’s Kleintop: 5 Surprises to Prepare for in 2015 on ThinkAdvisor.


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