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Kaboom!

01/15/2015

In the wee hours this morning, European stock markets went crazy.  Unexpectedly, the Swiss National Bank announced it was no longer supporting the cap on the Swiss franc, which immediately jumped almost 20% in value.  This was a huge unexpected jump to occur at one time.

Remember that Switzerland maintains its own currency and does not use the euro.  If the Swiss franc (called the Swissie) gets too strong against the euro, that will make the goods manufactured in Switzerland too expensive to be purchased by anybody using euros to buy the goods.  To keep this from happening, the Swiss National Bank (SNB) has been selling francs to buy euros, maintaining about 1.2 francs per euro.   The problem is that the euros were depreciating, causing losses on its balance sheet.

So, why stop supporting the Swissie now, after doing so for the last three years?  Because the quantitative easing in Europe is now almost certain to start next week and QE causes the currency to weaken.  (You’ll recall how the dollar began strengthening when we started tapering our QE.)  The sooner the SNB stopped supporting the franc, the sooner the drain on their balance sheet would stop.

The long term impact of this is hard to predict quickly.  It will now be extremely expensive for Europeans to visit Switzerland or buy anything from Switzerland.  It will also make it more expensive to buy from the U.S., because it is now very likely that the dollar will appreciate even more, which will put even more downward pressure on commodities like oil.  I suspect this finishes any chance that the Fed will raise interest rates this year, as that will only make the dollar even stronger.  Once that washes through the market, that should increase the value of high-yield bonds and dividend-paying stocks.  Our exporters, mostly large-cap stocks, will be hurt by increasing dollar strength.

If there is a lesson here, it is that no central bank can intervene in the currency market for long, not even the Swiss National Bank.  If there is a reminder here, it is that central banks must telegraph their actions and not surprise the markets.  

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