Switzerland threw the financial world into chaos when last month its central bank lifted the cap on its currency. Some experts say that the repercussions could continue to emerge for weeks, if not months, to come, and investors should be wary. Other experts, more sanguine on the matter, are urging calm, not panic.
Switzerland had maintained the cap on its currency for three years. However, just days after the country’s central bank described the cap as a cornerstone of its economic policy, the Swiss National Bank abruptly lifted the cap. The resulting surge in the currency’s value not only caused many banks and hedge funds deeply enmeshed in currency trades involving the franc to sustain massive losses, but also forced some of the latter to close down, as losses mounted to totals higher than their balance sheets.
The threat posed by the pending announcement by the European Central Bank of a massive QE move of more than a trillion euros was thought to spur the about-face in policy. And markets are still trying to figure out which sectors, in addition to the most obvious, such as luxury and tourism, could be in for the toughest slog.
Fitch Ratings said in analysis of the SNB’s move that “[a] sharp increase in a currency is generally bad news for exporters, which become less competitive. But we believe the impact in Switzerland will largely be felt by unrated small and medium exporters that manufacture domestically and whose costs are therefore predominantly in francs. Fitch-rated corporates such as Nestle, Holcim and Novartis tend to produce locally in the markets where they operate and therefore have a much larger proportion of costs in dollars and euros.”
But those smaller companies could have a tough time, and by extension bring it home—at least in the short term—since more than 40% of Swiss exports end up in the eurozone.
While the SNB’s action is “broadly negative” for Swiss companies, “the impact on Fitch-rated corporates will be limited,” the ratings agency said, since a “large proportion of their costs are overseas and the currencies of their assets and liabilities tend to be well matched.”
Fitch added that “There could be a negative impact on cash flow for companies that report in Swiss francs as the currency move will reduce revenue and to a lesser extent earnings, while dividends will continue to be paid in francs.” Debt coverage ratios for companies that mostly borrow in francs could also be impacted, said Fitch, although larger corporates will likely be hedged because of “match[ing] the currency of their revenue and debt, which limits the impact. Despite the cap on the franc for the last three years, Swiss corporates are used to dealing with significant currency volatility and stood up well to the last big move during the 2011 euro crisis.”
Longer term, the ratings agency said, the domestic operations of Swiss companies could also suffer if deflation weighed on economic growth. Another group that, oddly enough, could be in for some tough times are homeowners throughout eastern Europe and also in Austria. It became popular in the early 1990s for Austrians living near and working in Switzerland to take out mortgages in the Swiss franc, which at the time offered extremely low interest rates.
Despite the fact that workers were bringing in euros, not francs, the trend spread until it was banned in 2008. But the damage was already done; with the fall of communism in 1989, Austrian banks had begun offering mortgages denominated in Swiss francs via their growing networks throughout Hungary, Poland and Romania.
Fitch Ratings has said that four of Austria’s large banks—Bank Austria, Erste, Raiffeisen Bank International and Volksbanken—are carrying central and eastern European loans denominated in Swiss francs that are worth a total of 30 billion euros. However, the ratings agency has also said that the risk is low for the domestically held mortgages in Austria, thanks to clients who are relatively well off and to rising property values. Fitch said in a report, “With two thirds of Swiss franc mortgages held domestically, we expect asset quality deterioration to be moderate, despite the significant exposure.”
Unfortunately, the same may not be true for other homeowners, who are facing the challenge of paying off their mortgages in a currency worth more than the one in which they’re being paid. And that, of course, will have an impact on how much they are able to spend within their own economies.
Monty Guild, founder and CIO of Guild Investments, is considerably more cheerful on the subject than most of the headlines have been. “Switzerland made the courageous and wise choice by cutting themselves loose from the euro,” he said.
“We anticipate that it will be excellent for Swiss banking and won’t hurt major Swiss corporations—Novartis, watches, chocolates, etc.—because they do much of their manufacturing outside Switzerland. Swiss banks once again gain credibility, and people will want [to hold Swiss francs],” he said.