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SNB chairman Thomas Jordan recently defended the currency cap and said it was here to stay |
The unprecedented decision by the Swiss National Bank (SNB) on January 15 to scrap its policy of capping Switzerland’s currency at 1.20 francs to the euro sent shockwaves through financial markets.
In the immediate aftermath, the franc temporarily strengthened by up to 39% against the euro and dollar, and, as of January 20, USD/CHF was trading at around 0.87 compared with 1.01 just five days earlier.
The SNB’s sudden move is being attributed to the likely introduction of quantitative easing (QE) in Europe this week by the European Central Bank (ECB). Previously, the SNB maintained the floor since 2011 by buying billions of euros to keep the euro stronger than the Swiss franc.
“I think the SNB realized that ultimately QE will be introduced this week, and they couldn’t keep scooping up those euros,” says Neil Mellor, currency strategist at BNY Mellon. “The SNB is facing considerable losses on previous interventions.”
Investors that suffered the most were those who bet the Swiss franc would fall in value and leveraged their trades, in anticipation the 1.20 cap would remain firmly in place.
Higher dollar, lower euro
Investors have been moving funds into liquid US dollars and other safe-haven assets, says James Stanton, head of FX at advisory firm deVere Group.
Morgan Stanley’s FX research team recommends investors buy the dollar and sell the Swiss franc and euro, according to a note published after the SNB announcement.
The report says: “With the SNB citing divergences in monetary policies as one of the key reasons for taking off the peg, we expect the bank to potentially intervene and buy USD to help stave off some CHF trade-weighted appreciation.”
“Concurrently, with a significant buyer of EUR leaving the market and increasing pressure on the ECB to act, EUR/USD will continue to trend lower, we believe.”
Investors should factor in a “new era of a stronger dollar”, says Tom Elliott, international investment strategist at deVere.
Therefore, those investors with portfolios that have substantial exposure to stock markets and currencies of countries with considerable current-account deficits should rebalance their portfolios, as repayments and interest become relatively more expensive.
Meanwhile, the bearish story for gold has switched course, says Camilla Sutton, chief FX strategist at Scotiabank. The price of gold fell after the US staged a strong economic recovery and the US Federal Reserve announced an end to QE, but in recent days the price has, for now, moderately rebounded.
Before the volatility in the Swiss franc, the falling price of oil to less than $50 a barrel also shook currency markets. Therefore, one strategy that is uncorrelated to the US dollar would be to go long the Turkish lira and short the South African rand, says Vasileios Gkionakis, global head of FX strategy at UniCredit.
The decline in oil prices will filter through to lower inflation in Turkey, which will raise real rates and improve the country’s current-account balance, says Gkionakis. Conversely, the South African rand is more of a commodity currency, which will be affected by the fact China is in the midst of a structural slowdown.
Central bank back-pedalling
Volatility has been steadily returning to currency markets, but the SNB move came as a shock because its chairman Thomas Jordan has only recently defended the currency cap and said it was here to stay.
Traders have become accustomed to receiving forward guidance from central banks and trading on that information, so the SNB’s “back-pedalling” means that market participants will become more cautious about verbal commitments from central banks, says Gkionakis.
“[We are] moving into a higher volatility environment so macro-thematic traders will choose to express [their] views much more through optionality like simple call options,” he says.
“Personally, I don’t think people should try to get extremely smart because with more complicated structures, you run the risk of something going wrong.”
Meanwhile, traders await the finer details of the QE announcement this Thursday, but most are agreed that the euro is set for further weakness.
Thomas Köbel, an economist at SEB, says: “The euro will remain weak against the Swiss franc and there still seems to be downward pressure on the euro against the dollar in the medium-term.
“With the upcoming ECB QE programme, the euro will stay weak.”
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