The Swiss National Bank Capitulates On The Swiss Franc

Includes: FXE, FXF
by: Duru


The Swiss National Bank removes its 1.20 floor versus the euro and drops interest rates more deeply into negative territory.

The surprise move causes the Swiss franc to appreciate about 30% against the euro in a flash.

By leaving open the potential for further manipulation of the currency market, the Swiss National Bank has introduced a new source of uncertainty and perhaps isntability.

The Swiss national Bank (SNB) curtly reminded me that paper currencies are just the playthings of central banks.

Just over a week after I had start enjoying more actively shorting the Swiss franc (NYSE:FXF), the Swiss National Bank dropped a bomb on financial markets by announcing it will pull the rug from under the EUR/CHF by removing the 1.20 artificial floor. The impact was immediate and dramatic.

The euro plunges back toward parity with the Swiss franc as the SNB capitulates on its floor

There goes the entire length of the U.S. dollar's rally since the breakout from the summer of 2014

Source for charts:

The SNB's capitulation comes with a few vain attempts to smooth over this dramatic change in monetary policy. First, the SNB moved its range on three-month Libor further to -1.25% to −0.25% from −0.75% to 0.25%. As the chart above shows, these more deeply negative rates are not providing even a hint of disincentive from owning the Swiss franc. In a bewildering attempt to claim that the Swiss franc is not really all that strong after all, the SNB made the following observation on valuations:

"While the Swiss franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate. The economy was able to take advantage of this phase to adjust to the new situation."

Was the SNB referring to the levels before the change in policy or the anticipated level of plunging back toward parity against the euro? I find it hard to believe that overnight the SNB agreed with the market that a 30% or so appreciation in its currency is not really overvaluation "on the whole"! Adding to the surreal nature of this change is that just a few months ago, the SNB issued warnings about the impact of deflationary pressures on the Swiss economy. Just last month, the SNB revised downward its inflation forecast for 2015 to negative levels. A massive appreciation in the currency is certainly not inflationary!

Next up, the SNB suggested that it is really its exchange rate against the U.S. dollar that provided the final trigger on this decision:

"Recently, divergences between the monetary policies of the major currency areas have increased significantly - a trend that is likely to become even more pronounced. The euro has depreciated considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified."

This is a euphemistic way to refer to capitulation. It makes me wonder whether the SNB is (optimistically) expecting the Federal Reserve to proceed with its presumed 2015 start for rate hikes? I think if anything, the SNB is one more central bank providing justification for the Fed to chill out on rate hike talk in 2015. Time will soon tell!

Finally, the SNB makes a hopeful stab at guessing that more deeply negative rates will prevent an over-tightening of monetary conditions. The swift appreciation of the currency suggests not. Moreover, the SNB made a vague warning that it will continue to be active in the currency markets to implement its monetary policy. Nevermind that such an overt statement is supposed to be against international norms among nations with freely floating currencies…

"The SNB is lowering interest rates significantly to ensure that the discontinuation of the minimum exchange rate does not lead to an inappropriate tightening of monetary conditions. The SNB will continue to take account of the exchange rate situation in formulating its monetary policy in future. If necessary, it will therefore remain active in the foreign exchange market to influence monetary conditions."

This surprise move exposed a severe weakness in my trading strategy. Typically, I put a hedge in place on what I consider particularly speculative trades. I did not think shorting the franc was so speculative, yet a simple hedge shorting EUR/CHF would have served me VERY well. With hindsight, the stubborn strength of EUR/CHF hugging the 1.20 floor for so long, even after the first rate cut to negative territory, served as a warning that "something" was amiss.

As it stands, my exposure was thankfully relatively small as I was just in the beginning process of rebuilding positions short the franc. I have been executing my typical approach on these trades to buy dips and sell rips. This strategy also meant that I had some small limit orders at lower levels on AUD/CHF and USD/CHF that executed and delivered instant losses (it NEVER would have occurred to me to set my next opening level on USD/CHF at 0.90 or so!). For now, I will be holding these small positions to see whether the SNB decides to take the market for another loop and re-weaken its currency. At least I will get "paid" negative rates while I wait…

This whole episode reminds me of my own warning about the potential for more wild currency moves when I wrote "Parabolic Moves In The Ruble And Turkish Lira May Foreshadow The Same For The Australian Dollar."

Anyone got gold…?

Be careful out there!

Disclosure: The author is long GLD. In forex, I am short the Swiss franc.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.