This morning the Swiss National Bank (SNB) surprised the world by abandoning its managed Swiss franc floor against the euro. The SNB said as recently as Monday that they remained committed to the 1.20 minimum EUR/CHF rate, a floor they have maintained for three years. They also announced a further reduction to an already negative deposit rate. Swiss bank account holders will now be paying 0.75% for the privilege of having funds on deposit in the Swiss banking system.
The move by the SNB created a violent 28% collapse in EUR/CHF.
And, as you can see in the chart below, there was an equally violent collapse in USD/CHF.
After the initial massive gap in CHF pairs, the CHF is now trading well off of its strongest levels of the day. SNB chief Jordan said in his postpartum press conference that the Swiss franc dramatically overshot and that he expected it to ultimately reflect the fundamentals of a soft Swiss economy with negative deposit rates. This statement acknowledges the huge dislocation in USD/CHF that has resulted from the SNB’s actions.
The Fed and the SNB remain on divergent monetary policy paths. The Fed is exiting emergency policies, while the SNB is going further down the path of aggressive, extraordinary easing policies. This fundamentally drives capital out of Switzerland and into U.S. assets. The Swiss can now buy 10% more U.S. treasuries and U.S. stocks than they could yesterday at this time.
Why did the SNB do it?
Why did they reverse course on a policy they’ve held steadfastly for three years, and to which they have promised to remain committed? It’s likely because they are expecting big and bold actions from the ECB next week. The ECB has been explicitly devaluing the euro through their policies and policy guidance. Meanwhile, the Swiss National Bank has been persistently gobbling up euros in defense of their EUR/CHF exchange rate floor. That euro stockpile has been persistently losing value, and all evidence points to much larger losses ahead. With that, it appears most likely that the SNB decided to step out of the way of the downhill freight train, the euro.
For global markets, attention continues to be squarely on Europe. And today’s events highlight that point. Stocks, interest rates and currencies have been swinging around, driven primarily by fears that the deflationary problems in Europe are a deeper signal of weak global demand. But weak global demand isn’t a new problem. It has been a clear problem from the outset of the 7+ year global financial and economic crisis. That dynamic has been improving, not worsening. Europe, however, is facing deflationary pressures and no growth due to other factors, most importantly, while they should have been rolling out policies to promote growth in 2010, they further strangled growth by tightening the fiscal belt.
We will hear from the ECB on January 22. European officials have been on a media assault in recent days in an attempt to manage expectations on the ECB decision. With today’s SNB actions, an announcement of outright purchases of sovereign debt by the ECB are expected, and likely more to go along with it (like a further cut in the deposit rate).
On January 25th we get results on the Greek elections, which will determine whether or not a new administration takes the reins. The anti-euro, anti-bailout, Syriza party is favored to take control. This poses a risk to the Eurozone and the euro. This party is expected to, at best, demand softer conditions on their bailout and reform program. At worst, they are a threat to take Greece out of the European Monetary Union altogether.
But if we look at yields in the weak countries in the EMU (including Greece), those markets tell us that Greece isn’t a threat to euro zone stability.
Instead of yields in the troubled euro zone countries trading at unsustainable/default levels, yields in Italy and Spain are now trading below that of U.S. 10 year yields (well below 2%). Greek 10 year yields were trading over 40% at the peak of the European sovereign debt crisis. Now, Greek yields are well below 10%. So again, for those looking for smoke before fire, the European sovereign debt markets are giving you no signals.
For now, it’s about how big and how bold Draghi and company will be. Big action should be very good for the global economy and very good for global markets.
The theme of the year has been divergent policies, with the Fed positioned to exit emergency policies this year, while the ECB and BOJ are positioned to do more aggressive QE. When you step back from the day to day noise, that theme continues to play out, and it is good for global stocks, good for the dollar and good for global growth.