By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- How Swiss Decision to Scrap EUR/CHF Peg Affects You
- Is the Euro Headed for Parity?
- Money Pours into AUD and NZD
- USD/JPY Getting Cheap
How Swiss Decision to Scrap EUR/CHF Peg Affects You
Switzerland’s surprise decision to abandon their 1.20 EUR/CHF peg triggered vicious volatility in the foreign-exchange market. Their announcement drove EUR/CHF down nearly 30% at the on set, drove EUR/USD to 12-year lows, EUR/GBP to 6.5-year lows and EUR/NZD to record lows. There’s no doubt that their decision had a significant impact on the forex market but it also affects investors and traders across asset classes. First, it is important to recognize that almost no one expected the Swiss National Bank to scrap their 3.5-year peg. Everyone from bank analysts to hedge funds and institutional investors believed that the central bank would hold the peg at all costs and jumped in on the trade and now they can add EUR/CHF to their growing lists of trades gone wrong in the past 6 months (alongside oil and copper).
For U.S. investors, the SNB’s decision has a few ramifications
#1 Deleveraging
#2 Volatility
#3 Losses for Swiss Banks like UBS and Credit Suisse
#4 Gains for Treasuries
Just as we have seen how the decline in oil led to deleveraging in the financial markets (sell-off in stocks, rise in yen and rally in Treasuries), there has and should continue to be deleveraging after the SNB’s announcement. Investors will need to cover their losses by taking profits on profitable positions and which mean further declines in equities and another dip for USD/JPY. Volatility has been on the rise since the beginning of the year and the SNB’s announcement adds to the growing list of developments that could trigger greater volatility in the financial markets like the ECB rate decision and Greek elections in the first quarter of the year. The big moves will also force other central banks to respond – the central bank of India and Egypt lowered interest rates after the SNB announcement. At the same time these uncertainties and risks will increase the attractiveness of U.S. Treasuries. As for specific stocks, the surge in the Swiss franc will translate into losses for big names like (NYSE:UBS) and (NYSE:Credit Suisse), who derive most of their profits abroad.
Switzerland is taking a big risk by abandoning their peg. Their decision tells us two things – they expect the European Central Bank to announce Quantitative Easing next week and they feel that they can no longer afford to defend the 1.20 cap. We would be surprised if Jordan had not conferred with Draghi before making his decision. After spending billions of dollars on the peg, Thursday’s move represents a shift in tactics from an exchange-rate to an interest-rate driven policy. In addition to abandoning the peg, they also lowered interest rates but the only problem is that the deflationary impact of the sharp spike in the Franc may have overshadowed the effects of the rate cut. Now is not the time to buy EUR/CHF – beware of further losses and additional stimulative measures from the central bank.
Is the Euro Headed for Parity?
The euro dropped to 12 year lows against the U.S. dollar on the back of the SNB’s decision. Their announcement obviously had significant implications for the euro because the SNB defended their peg by buying a massive amount of euros but the question now is whether their decision impacts the ECB. The lower the euro falls, the less pressure on the ECB to intervene because the weakness of the euro helps to boost inflation and support growth. However given how much the central bank has prepared the market for Quantitative Easing, they risk sending the euro sharply higher, erasing all of the recent support by passing on the decision next week. The prospect of QE should keep the euro under pressure going into the rate decision but we are still looking for EUR/USD to bounce 48 hours ahead of the ECB announcement especially after today’s move. A lot of money was made selling euros and the uncertainty around the size and scope of next Thursday’s decision could lead to short covering. How euro trades after the meeting will hinge on the aggressiveness of the ECB’s program. If they under deliver, EUR/USD will rally but if they over deliver it could make a good dent toward parity. One-to-one against the dollar is possible but don’t expect a straight line downwards because 1.10 is a very important level and right now 1.15 is holding.
USD/JPY Getting Cheap
For the past few days we have been looking for the currency pair to break below 117 and having done so 2 days in a row, USD/JPY is starting to look like a bargain. Despite Wednesday’s big drop in retail sales, the tone of the Beige Book tells us that the Federal Reserve is optimistic and on track to raise interest rates this year. Of course, deleveraging poses downside risk to USD/JPY, but the currency pair is entering a value zone and so far 116.30 has held. Negative interest rates in Switzerland and the prospect of Quantitative Easing by the European Central Bank leaves the market looking for alternative safe havens. The Yen is attractive but not nearly as alluring as the dollar because the U.S. economy is actually improving while Japan is struggling. The Fed is one of a select few central banks looking to raise interest rates this year. Regardless of whether they choose to do so in the summer or fall doesn’t matter – the key is that they plan to do so period and that along with the loss of the Franc as a safe haven should make the dollar more attractive. In the long run, we are still looking for USD/JPY to revisit its 121.85 December high.
Money Pours into AUD and NZD
When the Swiss National Bank brought interest rates deeper into negative territory, investors were forced to look for alternative safe havens. This resulted in money pouring into Australia and New Zealand, two countries still offering an attractive yield. The rebound in gold and copper prices also increases the attractiveness of commodity currencies while healthier economic data from Australia gave hope for a stronger recovery. One of the biggest winners Thursday was the New Zealand dollar, which rose more than 1%. Like the Fed, New Zealand is one of the few central banks still talking about raising rates. While the Reserve Bank of Australia is comfortable with keeping rates steady, the surprise drop in the unemployment rate, larger increase in employment change and rise in the participation rate should make policymakers more comfortable with the outlook for the economy. The Canadian dollar on the other hand did not see much gains because existing home sales fell in December and oil prices turned lower after trading as high as $51.27 intraday.