Is the Latest Currency Decision A Swiss Miss?
On Thursday, January 15, something rather unheard of happened in Switzerland: the central bank abandoned a four-year-old policy that pegged the Swiss currency at Fr.1.2 to the euro. What resulted from this surprise decision was an instant spike in the evaluation of the Swiss franc vis-a-vis foreign currencies. In fact, the Swiss franc rose as high as 20% to 30% against a basket of currencies – something virtually unheard of in the currency trading arena in a single day. Typically, currencies will appreciate or depreciate up to 3 percentage points at any given time, but what happened with the franc was cause for alarm for many in the financial sector. The news is surprising, given the fact that the central bank intimated that it would not abandon the policy and would enforce it with the utmost determination.
Ramifications of Scrapping the Currency Cap
As the Swiss franc appreciates against the euro and the USD, importers benefit from the relative strength of the home currency against foreign currencies. However Swiss exporters are feeling the pinch because Swiss products are now that much more expensive on international markets. In fact, Richemont (SIX:CFR) and the Swatch Group AG (OTC:SWGAY) took big hits in Zürich following the news. The CEO of Swatch Group AG went as far as calling the scrapping a tsunami for tourism and the export industry. There are concerns that the effects of deflation are weighing heavily on economic performance in an already teetering European climate. Allied with that are near zero interest rates that cannot be cut much further to stimulate economic activity.
Scrapping the Cap – Good Move or Bad Move?
The Swiss were trying to protect their own currency by fixing the exchange rate of the Swiss franc to the euro at Fr.1.2. Switzerland has had negative interest rates for several weeks already, and there is a degree of confusion as to what effect the scrapping of the currency cap will have. The head of the national bank in Switzerland – Thomas Jordan – had the following to say:
‘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 a new situation.’
However, many analysts do not believe that these measures have had the effects that they were intended to have. However since the floor was introduced, the trend has continued growing higher. The effective exchange rate today is markedly higher than it was at the start of 2013. Currency traders have been scanning the markets to try and find safe havens for their investments, and while the greenback is bullish, many currency traders or the opinion that the Japanese yen is the currency to look out for. However, the Swiss franc remains a safe haven for currency traders. As a current-account currency, Switzerland is still faring very well.
The strengthening of the Swiss currency had a negative effect on the Swiss market index which plunged 10%, erasing Fr.133 billion off its face value. In terms of total exports, timepieces comprise over ten percent of Switzerland's exports, with big brands like Omega, Cartier, Rolex and Swatch dominating the global market. The reason the cap was implemented in the first place was to protect Switzerland's economy from the eurozone debt crisis. It's not only watchmakers that are feeling the pinch now it's pharmaceutical companies too. The export market accounts for a sizable portion of Switzerland’s revenues, and any increase in costs to foreign buyers will hurt domestic industry.
The Swiss National Bank (SNB) Decision Shocks the Markets
Countries that are feeling the pinch include Roche Holding (OTC:RHHBY) and Novartis Ag (OTC:NVSEF). Most everyone in the industry was caught unawares by the central bank's decision; there was predictability when the exchange rate was pegged to the Euro, but that's gone now. The scrapping of the cap also sent the franc to 3-year highs against the USD. The pressure was brought on by concerns that the European central bank would implement a widespread program of bond repurchases to ignite the forlorn European economy. Since the euro has been losing ground against the dollar, the Swiss do not want to move in a similar fashion with their currency. Unfortunately for many exporters in Switzerland, there has been no hedging with regards to currency exchange rates because everybody assumed that the SNB would keep things steady.
Chaotic Trading As Swiss Franc Gains Value in Cross Trading
The franc flirted with Sfr0.85 to euro briefly before dropping to Sfr1.02 in midday trading. The currency cap was a controversial policy as the SNB had to supply unlimited francs to meet the exchange rate requirements. The central bank had to keep the currency at its pegged value by printing excess supply of francs to drive down the price. The SNBs balance sheet reflected 60% of Gross Domestic Product. The Swiss National Bank may have decided that there is no point continuing to protect the exchange rate given the huge problems facing the euro on international markets. Some 60% of Swiss exports make their way to Europe and the US and the increased valuation of the Swiss currency will add strong downward pressure on local companies. With rising imports a likely outcome, the negative inflation rate (presently at -0.03%) in Switzerland will face increasing pressure. Ed Parker, managing director of sovereign ratings at Fitch, believes that the scrapping of the cap will not affect the Swiss credit rating. The change in monetary policy is an important determinant of the future strength of the Swiss economy, but it does not impact on Switzerland’s sovereign ratings.