The Fallout And Future Of The Franc
On January 15th, 2015, the Swiss decided to unpeg the Euro from the Franc. The announcement came unexpectedly and caused severe waves throughout economic circles and the world of forex trading. The Euro plummeted immediately against the Franc. The lowest point saw the Euro valued at 0.85 Francs down from the pegged rate of 1.2. The sharp drop is one of the most severe currency value movements since World War 1. The combined effect of the difficulties of the Euro with the unexpected nature of the announcement produced a knee-jerk reaction by institutions to ensure their losses could be covered.
In 2011, the Swiss National Bank decided to cap the Franc against the Euro in an effort to provide stability and safe haven in a chaotic European sector. The Franc is one of a handful of currencies that was viewed to be a safe haven against otherwise tumultuous markets. The cap was meant to solidify this further and create a welcoming environment for investors. The 2015 decision reflects the changed economic circumstances and what may be ahead for the Euro sector. Analysts point to several potential factors for this decision.
Potential Deciding Factors
The fears of Quantitative Easing by the European Central Bank.
One of the biggest recent news items was the consideration of Federal Reserve-style Quantitative Easing to try and combat the sour economic circumstances in the overall EU. The creation of additional Euros to buy up government debt in the EU will cause devaluation since more money is being produced. In turn, a pegged Swiss Franc could also be devalued if the government needs to create more money to maintain the cap.
A pegged Euro no longer makes sense for the Swiss.
Originally, the cap was a move to encourage investors to seek a safe haven in the Franc. A tremendous influx of investors drove the value of the Franc higher. An expensive Franc is bad for the Swiss economy because 70% of the Swiss GDP is tied to exports and services abroad.
The Franc has depreciated about 10% against the United States Dollar and Indian Rupee since the cap was installed. These two economies are of great importance to the Swiss because they account for nearly 20% of Swiss exports. The removal of the cap has allowed the Franc to gain against both of these currencies.
Overall Swiss sentiment has shifted on the policies of the SNB.
The pegged relationship was maintained by Switzerland creating more Francs and using those Francs to buy up Euros, balancing the value and keeping it an artificial level. The economic problems in the European Union have kept the Euro on a fairly steady downtrend for years now. As a result, the SNB now has a reserve of approximately $480 billion, about 70% of the total GDP for Switzerland. Ideally, the majority of the Swiss reserves should be in Francs or Franc-related instruments, not foreign currencies.
This fact has turned into a major political sore spot for the Swiss. The SNB was likely looking to end the unfettered growth of Swiss reserves in foreign currency that occurred in the past three years. Uncapping the Euro goes a long way to accomplishing that goal as the Swiss no longer need to produce currency and buy up Euros to maintain it.
There were several headlines about forex brokers being sucked under by the massive move of the Franc against other currencies when the announcement dropped. Notices and new policies flew out from various sources as institutions scrambled to minimize the damage while others were simply sucked under by the force. American institutions were hit with additional pre-emptive measures from the National Futures Association to attempt to minimize future damage from another drastic movement.
European stock markets tumbled as investors departed to safer havens like gold bullion and German bonds. Gold gained against all major currencies and hit a three month high after the announcement. It only took a few minutes for the Franc to gain almost 30% against the Euro and 25% against the United States Dollar.
The Swiss Exchange is expected to suffer due to value adjustment, preventing the Swiss from offering competitively priced goods and services to European consumers because of the disparity in value. UBS AG, a major Swiss financial institution that serves many tiers of investors and businesses, has changed their projection for Swiss economic growth from 1.8% to 0.5% with this announcement.
Ultimately, removal of the cap seems necessary with the measures that may be coming from the ECB in the near future. Critics are quick to point out that the Swiss should not have tried to create this safe haven in the first place because there did not appear to be any end to the European Union economic woes. Of course, it's easy to point that finger now, and there are undoubtedly many critics that had little to say when the policy was first announced.
As for how the Swiss Franc and economy will bear in the future? Overall projections paint a grey picture. The definite upside is the SNB will not be haemorrhaging Francs in trying to keep up with the ECB's anti-deflation measures. Unfortunately, the Swiss economy will still likely be fighting their own war with deflation.
The stockpile of foreign reserves can also be put to use in working to right the overall economic health. Given the sensitive political nature of the composition of the reserves, it wouldn't be surprising to see the SNB seek to put more of that money out there and convert it back into Francs or other safe haven instruments like bullion or bonds.