The Swiss National Bank had to act. It seemed clear that if it did not act, it would lose credibility and would increase the challenge of coping with a strong franc. As of yesterday, the Swiss franc had recouped about 50% of its losses since the SNB began flooding the market with liquidity.
News that Swiss inflation slipped to 0.2% year-over-year in August, the lowest since late 2009, left more than a whiff of deflation in the air. The SNB also reported that reserves jumped in Aug. to CHF253.4 bln from CHF182 bln in July, reflecting its intervention in the swaps market.
Contrary to what many had expected, the SNB drew the line in the sand at CHF1.20 for the euro. It stood ready to sell unlimited amount of Swiss francs to defend that level, which it knows still leaves the franc overvalued on a number of different metrics. The market responded immediately, pushing the franc sharply lower and bought to either cover, reduce underweight, or go long Swiss stocks (SMI rose 4.3%).
It is a bold move, and initially at least, the market is reluctant to fight the SNB. The euro has largely held above the CHF1.20 level. The real test of course is yet to come when the cause of its dramatic appreciation moves back to center stage and that is the EMU debt crisis. Often over the past year, there has been one main story in the eurozone: First Greece, then Ireland and Portugal, then Italy, France for a little. However, now it seems that there are two nodes -- Greece and its growth under performance and its deficit overshoot raising the risks of an disorderly default -- and Italy where the government has now called a confidence vote on Wed. over its austerity plan, which keeps changing. The latest version increases the VAT 1% to 21% and reinstate the levy on income of more than 500k euros.
There are several ramifications of the SNB's move, but before sketching these, let's focus on the policy itself. The damage inflicted by the dramatic appreciation of the franc appears to have created a political consensus in favor of action over inaction. And this means it is unlikely to be a contentious issue in next month's election. The paper losses the SNB may experience are thought to be preferable. At the same time, the cost of intervention may less than intuitively obvious given the interest rate differential between Switzerland and the countries whose paper it will buy.
While it will likely initially buy core bonds like Germany, France, Netherlands, Austria, and Finland, it will also probably diversify its reserve holdings into other countries outside the eurozone and the US. These may include Australia, Canada, Norway and Sweden.
The prospect of inflows coupled with the likelihood of further easing by the US and the softness of the world economy may encourage the shift in expectations that was already taking place against additional tightening among major industrialized countries.
The Reserve Bank of Australia is clearly in neutral, but the market is still pricing in over 100 bp of easing over the next 12 months, which seems too much. The Bank of Canada meets tomorrow and at least a rate cut before the end of the year seems increasingly likely. The rate hike the market has been pricing in for New Zealand may have to be re-thought.
Although the central banks of Norway and Sweden has signaled higher rates, policy makers are likely to go back to the drawing board. The euro fell to its lowest level against the Norwegian krone since early 2003 today. The krone was easily the best performing currency in the wake of the SNB's move. Denmark is also interesting. It has been attracting safe haven flows, prompting the central bank to shave rates on Aug. 25. An additional rate cut in the next week or so should not be surprising.
The Japanese yen weakened after the SNB's move. Recall that among the majors, speculators had their largest long currency position in yen. The SNB's move puts additional pressure on Japanese officials even if it is not obvious from the price action. In early August, after the SNB took first mover advantage, the BOJ intervened unilaterally the very next day. If there have been two main safe havens and you take one away, what's left? Despite the G7 meeting this weekend, coordinated intervention to stem the yen's appreciation is highly unlikely, leaving the new Japanese government will few options.
Broadly speaking, the SNB's move is a euro negative development and could very well serve as that trigger previously discussed to get the trend flowers and momentum players to believe that the proverbial train is leaving the station with few aboard.
The euro's price action is poor. Updating those short-term indicators I often find helpful, note that the two-year US-German spread has returned to practically where it start the year at 20 bp in Germany's favor despite the ECB hiking rates not once but twice this year and the Fed seemingly on the verge of additional easing. The risk-reversals (25 delta three-month) are at a new record premium for euro puts of over 4%. The euro is trading below its 200-day moving average which comes in near $1.4016 today. That area should act as resistance is this is going to be a clear break. Note too that the trend line that connects the July 12, Aug. 5 and Aug. 11 lows was tested on the initial knee jerk euro rally on the SNB announcement. It held and the euro is posting an outside down day. As mentioned, the net speculative position at the IMM is nearly flat and this is the kind of technical action that traders like to see.