The Swiss National Bank’s surrender to markets argues that next week’s Greek election and European Central Bank meeting will bring much danger and volatility.
The SNB’s abrupt climb-down from its vow to cap the value of the Swiss franc against the euro indicates a real, blood-cooling fear it could be swamped if either big event goes badly.
It also is a lesson in the limits of the powers of central banks, both in their fight against deflation and in battles with markets. This may influence their credibility outside Switzerland, and not for the better.
Three years after vowing to defend, in unlimited amounts if need be, a floor of 1.2 francs to the euro, the SNB on Thursday allowed the pair to float, touching off a 30% appreciation in the franc which settled to a gain of about 15% for the day.
Despite only this week calling the peg the cornerstone of its policy, the SNB stepped back, in the process making brave noises about the impact on the economy and the threat of deflation.
Even better, the SNB, while abandoning the peg and prompting that 15% one-day surge in the franc, also cut interest rates by another half percentage point, to -0.75%.
This was done, in the SNB’s words, “to ensure that the discontinuation of the minimum exchange rate does not lead to an inappropriate tightening of monetary conditions.” That is like shooting a man in the belly and putting a Band-Aid on his elbow so he doesn’t bleed too much.
There is no surprise that this is happening just before the ECB is set to meet on Jan. 22, when it is expected to announce an expanded program of quantitative easing which, if successful, will weaken the euro.
Just three days later Greece goes to the polls, an election which may well return a government whose policies over its debts risk a fracture with the rest of the eurozone.
Steven Englander, foreign exchange strategist at Citigroup, thinks the move may have been in anticipation of capital flows into Switzerland around the two events.
“They may be seeing signs already that these are ramping up. Otherwise the incentive would have been to wait and see whether events transpired as negatively as they feared,” Englander wrote in a note to clients.
“It is unlikely we think that the ECB has tipped off the SNB in any formal way, but it is possible that they inferred from informal conversations which way the wind was blowing.”
Whose ox gets gored?
Arguably this is helpful to the ECB, though how it plays out remains to be seen. While Swiss euro buying was a support to eurozone government bonds, so will be a weaker euro. As well, the ECB, as markets hope it demonstrates next week, can be far more effective and forceful in supporting its own bond markets than can the SNB through a back-door route.
The important thing to remember is that the SNB for three years was offering the world an escape hatch out of the euro: just apply, in unlimited size, and we’ll give you francs at a pre-agreed minimum.
That is a ‘picking up nickels in front of a steamroller’ strategy, and though the SNB and Switzerland have gotten some benefit out of it, the major risk is that should things go very badly for the euro project, or ECB QE, or both, they see the peg broken only after piling up many billions more euros.
Beyond pointing out the heightened event risk next week, the SNB’s move may have interesting longer-term implications for the rest of the world.
While this undermines central bank credibility as a whole, the line many will argue is between the big boys, like the ECB and Fed, and smaller fry like the SNB and Bank of England. Will the SNB’s climbdown lessen the value of Draghi’s “whatever it takes” pledge? Not so far, on the evidence, but bears watching.
The deflation angle is interesting here too. Obviously a much stronger currency will have a downward impact on inflation. This was part of the original justification for the peg, as well as protecting industry and tourism. Generally, the forces of deflation globally look to have the upper hand now.
All of this heightens the potential for further dovish behaviour from central banks: a big-bang QE from the ECB if it can make it happen politically and a further backing away from hikes by the Fed.
It is shaping up to be quite a week for tail risk, and potentially quite a year.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
