What's behind the Swiss National Bank decision?
Last week, the U-turn in the Swiss National Bank's monetary policy raised many questions. Notably is there something bigger afoot that might be totally unexpected by the markets?
Only three days after the SNB's vice-chairman, Jean-Pierre Danthine said the cap would remain the cornerstone of its monetary policy (while its president, Mr. Thomas Jordan, described the cap as "absolutely central" last month), the decision to abandon the Euro/Swiss franc floor of 1.2000, introduced on September 6, 2011, has no tangible explanations in our view.
We find it hard to accept the explanation that the decision was triggered by the upcoming European Central Bank massive bond-buying program that could have forced the SNB to massively sell Swiss francs for Euros to defend the cap, as the January 22 ECB decision does not make any doubt and as Mr. Draghi has been very vocal in the past few months about bringing the balance sheet of the ECB back to the levels of early 2012 (Euro 3 trillion).
We also find it hard to believe the SNB has more hints than anyone else in the market on what would have been the possible market reaction to the upcoming ECB announcement.
Finally we disagree with some comments that the size of the SNB's balance sheet was getting out of control as, at the end of 2014, the number stood at CHF 522 billion vs. CHF 490 billion at the end of 2013. There wasn't any sharp increase in the last few months, which could have triggered action.
Financial markets adjust to expectations, and expectations have been adjusted since June of last year (the Euro depreciated vs. the US dollar some 16%) when the ECB decided to suspend the weekly fine-tuning operation sterilizing the liquidity injected under the Securities Markets Program. If the ECB acts as expected, we would not be surprised to see the exact opposite market reaction on the Euro currency.
As expectations are already anchored to the reality, the SNB decision ahead of this important date simply makes no sense… unless the SNB expects something material to happen next week.
The return of national currencies in Europe?
With the move made by the SNB, we have reviewed the possibility that the Euro currency might disappear.
Many countries in Europe (notably the periphery) are still facing a recession which started in 2009, very high unemployment rates and increased aversion to austerity measures, making it impossible for politicians to implement further cuts (as it is the case for Greece).
Furthermore, the upcoming (January 25) elections in Greece and the possible win of the anti-austerity party Syriza put formidable pressure on the ECB and the EU political institutions.
An exit of Greece from the Euro would have profound consequences for the Euro structure as we know it, as it would set a precedent and as the exit risk would potentially spread to other countries (Italy, Spain, Portugal and maybe France) if this is not managed properly and orderly.
At the beginning of the year an article published by the German newspaper Bild stated that Germany was preparing a possible exit of Greece from the Eurozone. Even if officials (including Mrs. Merkel) denied, we believe this article has to be taken seriously given the SNB decision to abandon the peg just days ahead of the ECB announcement and ahead of Greek elections.
Last but not least, since the terrorists' attacks in Paris, many European countries are asking for a review of the Schengen treaties (free movement of people and trade across Europe), which is an additional burden for the overall structure of Europe.
We believe that a return to national currencies is something maybe unavoidable, manageable (both in legal and technical terms) and positive for many countries (notably the periphery) if this is well prepared.
While sovereign (Greece notably) and corporate (banks notably) defaults are unavoidable, the European Central Bank and Europe are now well prepared to deal with this outcome since the comprehensive assessment plan of the EU banks was finalized last October and the Single Supervisory Mechanism has become fully operational.
If national currencies were to be reintroduced in Europe now, the chaos this would trigger would be very manageable and shouldn't lead to major disruptions of the markets, compared to two years ago.
Europe would find itself in the pre-Euro currency era where weaker countries (notably the south ones) carry higher interest rates and inflation and devalue their currency in order to get more competitive while the north ones would have stronger currencies and much lower interest rates.
With this in mind, it would be up to each of the EU governments (and not to a central government which is unable to have a common ground) to implement the needed reforms in its country, in order to attract the needed capital and adjust accordingly.
In terms of investments, the only way to protect from this possible outcome is to have an equity exposure (excluding banks and insurances) that would overshadow any currency loss.
The German stock market and other northern Europe markets would likely be the most affected, as the German currency would likely rerate while the periphery markets (notably Italy, France and Spain) would get a boost as their currencies weaken.
Precious metals would also benefit in the short-term if the return to multiple EU currencies happens.
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