Yesterday’s markets were one for the history books as the Swiss National Bank dropped a bomb on the currency space. By cancelling its floor in EUR/CHF, that limited the value of the Swiss franc from breaking the 1.20 level, it has ended a 3½ year monetary policy experiment with neither a blue riband nor a deafening silence but instead with a sickening crash.
Why the Swiss National Bank decided to end its policy yesterday lies within two current market scenarios that have put an unbelievable amount of pressure on its arrangement within currency markets. The most shocking facet of this move was the sudden nature of it all. Central banks have made huge efforts in trying to be transparent through forward guidance, the publication of minutes from meetings and targeting unemployment. The SNB announcement was a mugging.
The main motivation of the SNB is a capitulation in the face of a tide of European selling that is forecast to be started by next week’s European Central Bank meeting and the likely announcement of an asset purchase program.
I am personally unsure as to the relationship and the communications between the SNB President Thomas Jordan and his ECB counterpart Mario Draghi, however the former has obviously had enough of chaining his bank’s monetary policy to that of the latter. The pressure and belief that the European Central Bank will launch a bond buying program in the coming week – further devaluing its currency – has been enough to make the Swiss National Bank step out of the way. Nobody wins when you stand in the way of a freight train, except for the train.
The other scenario that has driven CHF buying is its constant requirement by investors looking for a safe haven asset. We have seen Russian money move into Swiss assets in the past year as an escape from sanctions and a haven from the collapse of both the ruble and the oil price. CHF had become almost too safe. The SNB’s imposition of negative interest rates on deposits is designed to halt these flows but will do little in the short term one has to think.
Longer-term policy will likely see a peg of the Swiss franc reintroduced, however, not against a single currency. More likely, this will be constructed to sit against a basket of currencies (USD, EUR, GBP, JPY etc.) to allow for a more blended reaction of the CHF and a more rounded monetary policy outcome. This should allow for franc weakness but that has been said before and look where it got us.
The impact of the announcement was immediate and the Swiss franc that has been kept unnaturally low finally found an environment to stretch its legs. At its strongest, the franc was nearly 40% higher against the euro but finished the day around 18% up against its crosses.
With all this going on, England could have invaded Scotland and installed David Beckham as First Minister and it would have been bumped from the front page. Sterling drove higher on the associated European single currency weakness, to fresh near-seven year highs, close to the 1.31 mark. We had thought the 1.30 mark would give way in the run-in to the European Central Bank meeting next week. Needless to say it was not because we thought the SNB would surrender with such alarming speed.
We have to think that the weakness in the euro will be maintained into next week’s ECB meeting – due Thursday – and that further gains for the increasingly safe haven pound may be forthcoming. Today’s inflation readings from both the eurozone and the US are more than likely to continue the relative divergence between the two currencies. As we have seen with other inflation announcements in recent weeks it is not so much about the headline index but more the ‘core’ reading. The deleterious effects of falling commodity and energy prices are obvious but should an economy’s ‘core’ prices – that do not include these volatile measures – remain strong, that is cause for optimism and will eliminate near-term fears of outright deflation. Eurozone inflation numbers are due at 10am whilst the US’s will be released at 1.30pm.
Elsewhere, we can expect another volatile session today as traders make preparations for next week’s influences, amongst which we have a Bank of Japan policy meeting, the ECB meeting, Greek elections and further fallout from the Swiss move yesterday.
