By John Brynjolfsson
1) This morning's surprise announcement the Swiss National Bank (SNB) is first and foremost a SNB declaration of independence.
- Renounces ties to Euro explicitly.
- Implicitly renounces ties to ECB, Eurozone, European Court of Justice (which Rule yesterday in support of the ECB’s OMT, that is buying, of periphery debt), and Greek elections.
- Obviously Switzerland has a long history of remaining fiercely independent, whereas the 2 year old announcement of a floor had unwittingly become an unwelcome alliance of the country’s central bank.
2) It is neither an easing nor tightening, as announcement has aspects of both.
- To the extent ECB is obviously easy, easing, and likely to do QE in the coming weeks, exiting that alliance is an implicit tightening by the SNB.
- However, the SNB also eased rates (from -0.25% to -0.75%). As such it is an easing.
- It appears, to me, that these two offset.
3) The SNB announcement is also an implicit signal, or strong hint, that the ECB will be aggressive in its QE and support of the periphery in its Jan 22 announcements. Though I (echoing a note by Citi Analysts Jason Englander) know of no formal communication between the ECB and SNB on such matters, presumably the central banker’s at SNB would be informally briefed by ECB officials, and may have an ability to read between lines.
4) Many professional speculators have been caught “offsides”. The cost of a “carry” trade in which a yield hog goes long the vulnerable Euro and short the more durable Swiss Franc, in exchange for picking up the yield differential, is that Euro may depreciate. To the extent the yield hog assumes this downside in the Euro is limited by the announced 1.20 floor on the Euro versus Swiss Franc, the trade becomes very attractive to the naïve speculator when the EURCHF hovers just above the 1.20 floor. (I say “niave” because they seemly haven’t adequately asked the question, “why is it so close to the floor?”. For example at 1.2010, the downside is “limited” to 0.08% while carry may be 0.50% or more (per year). Obviously such carry would typically be levered 20X if double digit carry was the goal.
5) The problem is that if the floor ever breaks, its lights out for the carry traders. This morning, panic short covering by such carry traders was likely the driver of the temporary downside overshoot of the exchange rate. The Euro’s exchange rate versus the Franc appears to have settled in, for now near 1.04 CHF/EUR about 12% below the prior 1.20 floor. (Meaning the Swiss Franc strengthened 12%).
6) The implications for EUR is generally negative and US Treasuries positive. Meanwhile the implications for Euro periphery spreads and EUR rates are small or ambiguous. In particular, though the SNB voted “no confidence” in the periphery strategy and will presumably be less aggressive in buying Euro sovereign debt, they simultaneously implicitly revealed that their read is that Frankfurt would be aggressive in its support of the periphery and in QE more generally.
7) Likewise, I would presume the SNB will buy less Euro denominated assets, and more US Treasuries, which should be negative for the EUR and positive the USTs.
Mr. Brynjolfsson John.Brynjolfsson@ArmoredWolf.com oversees all investment activity at Armored Wolf. A popular and provocative communicator, Mr. Brynjolfsson is a frequent guest on CNBC, Bloomberg TV and PBS’s Wealth Track; has been quoted in The New York Times and the Wall Street Journal and featured in Fortune; is a member of industry advisory committees; and has testified before the House Financial Services Committee as an expert on catastrophic risk transfer. Mr. Brynjolfsson is co-author of Inflation-Protection Bonds and co-editor of The Handbook of Inflation-Indexed Bonds. He has more than 20 years of investment experience and holds a bachelor’s degree in physics and mathematics from Columbia College and a master’s degree in finance and economics from the MIT Sloan School of Management.