There is indeed a special feeling to seeing history being made in front of your eyes — even if it is only being seen via a computer screen — and yesterday (Thursday) was one of those historic days.
The specific event in question was the decision by the Swiss National Bank (SNB) to ‘lift the cap’ — i.e. terminate the policy it instigated in August 2011, which placed a ceiling of 1.20 Swiss francs to the euro. At that time, the Eurozone crisis was at its height, generating huge capital inflows into Switzerland, seeking a ‘safe haven’ from crumbling currencies. The upward pressure on the Swiss franc pushed its value as high as parity to the euro (one-to-one) and posed an existential threat to Swiss industry, by rendering it uncompetitive in world markets.
The SNB’s decision then to effectively link the Swiss franc to the euro at the rate of 1.2:1, by committing itself to buy any amount of euros at that level to prevent it rising higher, was incredibly brave. It involved deliberately sacrificing the Swiss currency’s famous stability for the sake of the country’s export industries. The SNB was obliged to buy huge amounts of euros over the following year and its balance sheet swelled to several times its previous, normal, size.
Nevertheless, the cost was seen as justified and the bank won kudos both at home and abroad. Everyone saw the SNB as committed to maintaining the peg indefinitely. Here was a central bank which didn’t just talk the talk, like the ECB, but walked the walk, big time. As recently as a few days ago, members of the bank’s governing council were giving the impression, in their public speeches, that the peg policy was open-ended.
Yet yesterday forenoon, Swiss time, with American traders still asleep and Asian traders gone home for the day, the SNB announced that it was terminating the policy. At the same time, it was pushing its own interest rate deeper into negative territory, so that anyone holding Swiss francs would have to pay for the privilege.
The immediate impact, on the Swiss currency and on bonds denominated in francs, as well as on Swiss companies’ shares, can only be described as breath-taking, and/ or stunning.
A tsunami of buying sent the Swiss franc through the former red line of 1.20, underneath which a vast number of ‘stop-loss’ orders had been placed. These were triggered en masse and the currency soared within minutes by some 30% — yes, that’s thirty per cent, for the most stable currency in the world — against the euro, to 85 centimes to the euro, before eventually stabilizing at around 1.03-1.05 francs per euro.
Against the dollar, the franc had been trading at about 1.02 francs to the dollar. But, in seconds, the franc zoomed to 0.75 to the dollar, before settling back to trade just below 0.9. The rush of money into franc-denominated assets sent Swiss government bond prices even higher than they already were, so that yields went negative along the curve all the way to 9-year durations.
The impact on shares was the mirror-image to that on bonds. The big Swiss companies, whether banks, pharma or engineering, make their money globally and when they convert this back into francs at their new high value, their revenues and profits will shrivel. Their share prices, for once acting entirely in line with economic and business fundamentals, discounted this tremendous blow immediately — and plunged by as much as 15% at one point, the largest such fall on the Zurich exchange since 1989.
Meanwhile, outside of Switzerland and Swiss assets, there was total confusion, turmoil, panic and extraordinary volatility. Shares in Germany and other European countries, which had been rising, plunged dramatically — and then began rising again and continued to do so through the day, so that many bourses ended with gains of over 2%, while Zurich ended 800 points, or 9%, lower.
Oil prices and other commodities also gyrated — probably because many speculators, such as hedge funds, had taken loans in Swiss francs and relied on the SNB to prevent the ‘Swissie’ going up. The spike in the franc’s value will have resulted in immediate margin calls and the forcible closing of their positions, with all the losses that entails. Over the coming days we will learn exactly who suffered this fate.
The market action was indeed historic — but this is not just an event that affects markets. On the contrary, it has enormous implications for the real economy — and not just in Switzerland, but everywhere.
The rationale behind the move, it is widely believed, was that next week the ECB is going to launch a massive program of QE, to buy European government bonds on an enormous scale. This will drive the euro down even further and would probably have caused additional inflows into Switzerland, which the SNB felt it could not — or at least did not want to — absorb.
In other words, yesterday witnessed a central bank fold its hand and quit the game. The implication of this development is even more dramatic than the market’s gyrations: central banks are not all-powerful after all and if you rely on them you might end up betrayed and bankrupt. The Swiss chose to sow the wind and now they — and everyone — will reap the whirlwind.