Post by Oz-T on Jan 16, 2015 0:26:56 GMT
I cannot recall ever seeing this before: a major world currency appreciating against another by 20% in just five minutes. That's what happened yesterday to the Swiss Franc and the Euro.
And it caused massive gyrations on currency markets - and also the stockmarkets.
How this all started
To understand what happened, you need to go back to 2011 and the culprit is obvious: Greece. During one of the many crises caused by Greek debt, the euro was suffering and this affected Switzerland because it was seen as a European safe harbour that did not belong to the Eurozone. Seen as a strong economy with an equally strong currency, Switzerland became the ideal European haven for money. The more money flowing into Switzerland, the higher the franc appreciated against the euro.
By mid-2011 this was causing immense problems. Swiss exports were being hurt due to the high exchange rate, making their products too expensive for the rest of the world to buy. Many businesses considered leaving Switzerland. And the Swiss National Bank (SNB) even lowered short term interest rates to negative.
In September the SNB acted on this threat to the Swiss economy – it imposed a minimum exchange rate of 1.20 francs for each euro. This not only stopped the franc appreciating, it actually dropped abruptly against the euro. The immediate crisis was averted and the situation stabilised. To help reduce demand for francs, the SNB increased supply by printing more banknotes. Swiss banks have also kept interest rates very low, making it less attractive to buy francs to deposit there.
Imbalances in the Swiss economy
But in the long term, artificial caps on exchange rates don’t necessarily work as well as planned. The SNB policies increased liquidity, which fed into property prices and the booming sharemarket. Low interest rates cause property speculation because it’s so cheap to finance. That feeds into social problems of home affordability and the risk of a property bubble bursting.
And with the recent further weakness in the euro (caused again by jitters about Greek debt, as well as the European Central Bank’s announcement that it’d print more euros), the pressure continued to threaten the Swiss economy – with no end in sight.
The market explodes
All this led to yesterday’s announcement by the SNB that it would immediately remove the three-year currency cap. Currency markets immediately responded, causing the franc to skyrocket 20% against the euro, before settling at a 17% gain (at the time of me writing this, 15 hours later). Following the euro, other currencies fell against the Swiss Franc by similar amounts. The Swiss sharemarket, fearing the effect this will have on exports has suddenly fallen 10%.
What happens next?
Sudden changes like this one cause ripples in all directions. The immediate effect will be some massive losses and profits by hedge funds, banks and traders, depending on which currencies they’re holding and whatever bets they made on them. Any trader suffering huge losses may be forced into selling other assets to cover the setbacks. Investors will look for safety, turning to German bonds, gold or US markets. They will reappraise risky assets and try to reduce risks, perhaps by selling them to somebody else. There will likely be a period of turbulence and volatility.
And for anybody travelling to Switzerland, it has just become more expensive (about 17%) due to your own currency’s exchange rate falling against the Swiss franc. It will be interesting to see how tour companies react to this because they lock in their brochure prices a year before the tours occur. If their profit margins are sufficiently high, or if they have currency hedges in place, they should be able to wear this. But I sometimes wonder whether any of them would sneakily cancel any loss-making tours on the pretence that there are insufficient passenger numbers. As they are the only ones who know the total bookings it would be easy to get away with this sort of practice.
And it caused massive gyrations on currency markets - and also the stockmarkets.
How this all started
To understand what happened, you need to go back to 2011 and the culprit is obvious: Greece. During one of the many crises caused by Greek debt, the euro was suffering and this affected Switzerland because it was seen as a European safe harbour that did not belong to the Eurozone. Seen as a strong economy with an equally strong currency, Switzerland became the ideal European haven for money. The more money flowing into Switzerland, the higher the franc appreciated against the euro.
By mid-2011 this was causing immense problems. Swiss exports were being hurt due to the high exchange rate, making their products too expensive for the rest of the world to buy. Many businesses considered leaving Switzerland. And the Swiss National Bank (SNB) even lowered short term interest rates to negative.
In September the SNB acted on this threat to the Swiss economy – it imposed a minimum exchange rate of 1.20 francs for each euro. This not only stopped the franc appreciating, it actually dropped abruptly against the euro. The immediate crisis was averted and the situation stabilised. To help reduce demand for francs, the SNB increased supply by printing more banknotes. Swiss banks have also kept interest rates very low, making it less attractive to buy francs to deposit there.
Imbalances in the Swiss economy
But in the long term, artificial caps on exchange rates don’t necessarily work as well as planned. The SNB policies increased liquidity, which fed into property prices and the booming sharemarket. Low interest rates cause property speculation because it’s so cheap to finance. That feeds into social problems of home affordability and the risk of a property bubble bursting.
And with the recent further weakness in the euro (caused again by jitters about Greek debt, as well as the European Central Bank’s announcement that it’d print more euros), the pressure continued to threaten the Swiss economy – with no end in sight.
The market explodes
All this led to yesterday’s announcement by the SNB that it would immediately remove the three-year currency cap. Currency markets immediately responded, causing the franc to skyrocket 20% against the euro, before settling at a 17% gain (at the time of me writing this, 15 hours later). Following the euro, other currencies fell against the Swiss Franc by similar amounts. The Swiss sharemarket, fearing the effect this will have on exports has suddenly fallen 10%.
What happens next?
Sudden changes like this one cause ripples in all directions. The immediate effect will be some massive losses and profits by hedge funds, banks and traders, depending on which currencies they’re holding and whatever bets they made on them. Any trader suffering huge losses may be forced into selling other assets to cover the setbacks. Investors will look for safety, turning to German bonds, gold or US markets. They will reappraise risky assets and try to reduce risks, perhaps by selling them to somebody else. There will likely be a period of turbulence and volatility.
And for anybody travelling to Switzerland, it has just become more expensive (about 17%) due to your own currency’s exchange rate falling against the Swiss franc. It will be interesting to see how tour companies react to this because they lock in their brochure prices a year before the tours occur. If their profit margins are sufficiently high, or if they have currency hedges in place, they should be able to wear this. But I sometimes wonder whether any of them would sneakily cancel any loss-making tours on the pretence that there are insufficient passenger numbers. As they are the only ones who know the total bookings it would be easy to get away with this sort of practice.
