Surprise Move by Swiss Central Bank Shows Franc Isn't As Good As Gold

01/15/2015 8:16 pm EST


Jim Jubak

Founder and Editor,

Today’s move by the Swiss National Bank resulted in massive losses across the currency markets, and MoneyShow’s Jim Jubak highlights how precious metals—at least in the short-term—became the winner and what this action out of Switzerland does to the opinion of what will happen next week.

As good as gold? Not today.

Chaos erupted across global currency markets this morning as the Swiss central bank abandoned its three-year old policy of capping the appreciation of the Swiss franc against the euro. At one point this morning in London, the franc was up 41% against the euro.

The result is massive losses across the currency markets as any one short the Swiss franc took a bath on the jump. Bank currency desks were swamped with orders and at least one electronic exchange halted trading. The big banks in the currency market—Deutsche Bank, Citigroup, UBS, and Barclays—at this point are simply trying to figure out their net exposure to the move since, as dealers, these banks often act as the other end of currency trades. Banks and traders that had used the Swiss franc as part of a spread trade—going long the dollar or yen for example and short the franc—are likely to face big losses since no one was anticipating anything like this volatility in the Swiss franc. The central bank’s floor on the franc made it a risk-free trade, since, even if, say, the euro went down, the Swiss franc wasn’t going anywhere. The rise in volatility in the franc, even without the huge absolute change in price, is likely to have inflicted big losses on some options positions since volatility moves the price of an option. Mortgage borrowers in Eastern Europe, where low interest loans denominated in Swiss francs were extremely popular, now face a huge increase in their mortgage payments thanks to the increase in the price of the Swiss franc. Banks that made these loans, including Italy’s Unicredit, Austria’s Erste Group, and Hungary’s OTP Bank, are likely to see either rising defaults on these mortgages or to take big losses as national governments force the conversion of these mortgages into local currencies. In Hungary, for instance, a law passed in November requires banks to convert loans from Swiss francs to Hungarian forints at 257 forints to a Swiss franc. The exchange rate today, however, was 310 forints to a franc.

The winner, certainly in the short-term is gold—and silver, platinum, and palladium—since the new volatility of the Swiss franc will make it a less certain store of value. Gold for February 15 delivery closed up 2.02% today at $1259.40 an ounce. Shares of gold mining companies, which are leveraged to the price of gold, climbed even more with stocks such as Newmont Mining (NEM) up 8.86% and Yamana Gold (AUY) ahead 6.58%.

Why did the Swiss central bank move now to abandon its pledge to keep the Swiss franc at 1.20 to the euro? The consensus today is that the Swiss central bank moved in anticipation of a decision next week by the European Central Bank to launch a huge program of asset purchases that would further weaken the euro. The conspiracy theory of the day—which actually makes a lot of sense—is that the European Central Bank tipped off its Swiss counterpart. Which led the Swiss central bank to conclude that keeping the Swiss franc from significantly appreciating against the euro was about to become a whole lot more expensive and could lead to major distortions in the Swiss economy as the bank pumped francs into the market to weaken its currency. And, of course, I’m sure the Swiss National Bank considered the possibility that it wouldn’t be able to keep the franc from appreciating against the euro anyway.

That conspiracy theory makes sense but that doesn’t mean it’s true. The theory relies on a belief that the European Central Bank has reached a decision on beginning a program of asset purchases—a Federal Reserve-style quantitative easing—at its meeting in Frankfurt on January 22. Given opposition to the program from Germany and most adamantly recently from Finland, and the difficulty in working out the details of that program, I’m not sure that’s a low risk assumption. Besides the issue of whether to buy sovereign debt at all—and for this program to reach a size where it might be able to move the needle on inflation and growth it has to include the purchase of government debt—there’s a question of how to allocate those purchases. What I’ll call the German bloc at the bank opposes any plan that weights purchases toward the most indebted members of the EuroZone such as Greece. Of course, that’s the formula that’s most likely to have the biggest effect. Allocating the purchases by size of economy winds up with the central bank buying a big chunk of already low yielding Germany bonds.

Before today’s move by the Swiss National Bank, the market seemed about equally divided between those who thought the European Central Bank would simply issue a statement at next week’s meeting saying it would start a program of asset purchases sometime in the future and those who thought the bank would actually put a plan in place. Today’s action out of Switzerland has pushed opinion toward a belief in action next week. And that raises the possibility of a market disappointment if the European Central Bank doesn’t act and simply talks.

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