Euclid on Swiss Central Bank’s Surprise Move
The Swiss National Bank (SNB) dropped a bombshell on foreign exchange currency (FX) markets Thursday by pulling the plug on the Swiss franc peg against the euro. Switzerland’s central bank may have been concerned about adding further to the size of its balance sheet since putting the cap in place three years ago in a move to shield its economy from Europe’s sovereign debt crisis. In all likelihood, the SNB wanted to get out ahead of the European Central Bank’s quantitative easing announcement expected for next week, which would have exacerbated the Swiss franc’s strength.
The SNB’s unexpected move adds huge volatility to FX markets and raises the stakes for ECB President Mario Draghi, who is under growing pressure to decide what form and quantity of QE he will announce at next week’s ECB meeting. Because the Swiss have front-run him, Mr. Draghi risks losing credibility if he does not come through with strong enough QE measures that can kick-start the slumbering European economy. There may be no better method to accomplish that than to create a sizeable decline in the euro. Judging from yesterday’s swift reaction to the SNB announcement, if the ECB takes dramatic steps next week, the FX markets will certainly pay attention. The Swiss franc is up 16% as of this writing.
Swiss-based companies will feel the greatest pinch as a result of the SNB’s actions, as exports become more expensive, imports cheaper, and the country’s economy slows. The Swatch Group CEO probably put it best, calling the SNB’s action “a tsunami for the entire country." The CIO of UBS’s wealth management business also suggested that while Switzerland’s net exports will decline, they would be somewhat offset by higher consumption off the back of lower interest rates and oil prices. Swiss GDP growth estimates for 2015 and 2016 might be cut to 0.5% and 1.1%, from 1.8% and 1.7% previously.
At Euclid, currency analysis is an important part of our research process, but even more so when the cross-currents of central bank policy changes are a routine source of volatility in global markets. What do we make of the current developments? We think that Mr. Draghi will not disappoint. Look for above consensus ( > 500-600 billion euros) QE from the ECB on January 22. This should be positively received by the market, for financial assets in general and the banking sector more specifically.