On January 8, I wrote about the Swiss National Bank (SNB) keeping the exchange rate between the euro and the Swiss franc at 1.20 or higher. This means the euro can purchase at least 1.20 francs. If the exchange rate fell below 1.20, then the SNB would print new francs and use them to buy euros.
As I commented back then, the program kept the franc from getting stronger against the euro, which kept Swiss exports from getting too expensive when priced in euros.
The SNB put the exchange rate floor in place in September of 2011, and as recently as January 12 they reaffirmed their intent to maintain the minimum 1.20 exchange rate. But recent developments have caused problems for the SNB.
Over the past six months, the euro has been falling as investors prepared for a European Central Bank (ECB) quantitative easing (QE) program. Since July 2014, the euro sank from $1.35 to $1.16, a drop of 15%.
The SNB kept its program in place, so the euro/franc exchange rate remained at 1.20 or higher. Unfortunately, as I noted on January 8, this means that as the euro fell in value relative to most other currencies, it dragged the franc down with it…
As the franc devalued, the Swiss had to pay more for imports from China, the U.S., and basically everywhere but the euro zone, which meant a lower standard of living for the everyday citizen.
Too Much for the SNB to Bear
On January 15, just two days after they had reaffirmed their intent to hold the line at 1.20, the SNB announced that it would stop supporting the euro/franc exchange rate and would let the currency pair float freely. Market reactions were swift and dramatic.
At first the franc shot much higher in value, trading as high as 0.90 franc per euro, which is a drop of 30 cents in a matter of minutes; however, the exchange rate recovered a bit in the hours that followed and settled in around 1.05 francs per euro.
Since the move by the SNB was a surprise, all of the currency traders that were betting on the SNB supporting the 1.20 level were blindsided. A common trade was to have a standing order to go short the Swiss franc in euros when the price dropped below 1.20.
This made sense because the SNB was going to step in and make the franc cheaper, as it had every time the exchange rate fell below that level since September 2011. This was a guaranteed moneymaker for more than three years!
But this time the SNB did not step in, so traders ended up short the Swiss franc and long euros, only to watch the Swiss franc shoot higher in value as the exchange rate continued to fall.
There’s no estimate yet on how much money was lost, but it was probably in the billions of dollars.
It might seem like the Swiss capitulated, and did so at exactly the wrong time — just ahead of the ECB’s announcement on a QE program. Given that the euro has dropped so far already and interest rates are exceptionally low across the euro zone (two-year governrnment bonds in eight European countries have yields below zero), it’s easy to see how the ECB could disappoint the markets with too modest of a plan, leading to the euro moving back up a bit.
But the Swiss might win this war after all by using negative interest rates.
When the SNB cut the cord of support for the euro/franc exchange rate, it also tripled the interest rate it charges on sight deposits (immediately available deposits from banks) from 0.25% to 0.75%. This means that depositors who are using the Swiss franc as a safe haven will have to pay a hefty penalty to keep their funds on hand.
The huge charge on deposits could also have the beneficial effect of stimulating the Swiss economy, which has stalled in recent months along with the rest of Europe.
No matter what happens, one thing is certain — we’re living through a time of extraordinarily low interest rates, where depositors in many countries are charged for the privilege of holding their funds in banks.
As Lance Gaitan discusses below in Ahead of the Curve, low interest rates are prevalent in developed nations around the world, which makes our paltry rates on U.S. governrnment debt look like high-yield offerings!
Ahead of the Curve with Lance Gaitan
Defining Low Interest Rates