Written by Aditya Garg
That seemed to be the general sentiment on January 15th when the Swiss National Bank (SNB) suddenly announced that it would no longer keep the Swiss Franc at a fixed exchange rate with the Euro.
In the course of one day, the franc appreciated at a rate such that one euro went from being worth 1.2 Swiss francs to a low of 0.85 francs leading to hundreds of millions of dollars in losses for many traders, currency brokers, and banks, including Barclays and Deutsche Bank.
For instance, FXCM, the largest retail currency broker in the world had to be rescued by a $300 million lifeline from Leucadia National Corp. Its shares were suspended on the NYSE that day because clients’ losses could put it in violation of regulatory capital rules.
Christine Lagarde, head of the IMF, commented later that day that she was “surprised” she had not been alerted earlier.
However, SNB Chairman Thomas Jordan offered some insight. At a news conference, he argued that, “If you decide to exit such a policy, you have to take the markets by surprise.”
But what motivated this sudden change?
The peg was originally introduced in 2011 to protect the Franc from appreciating any further. The Swiss Franc was looked upon as a safe haven currency and so in the aftermath of the financial crisis, the flood of money led the Franc to appreciate nearly 40% over the course of one year – severely hurting exporters.
The Swiss held this peg for 3 years so that by 2014, the SNB had nearly $480 billion worth of foreign currency (about 70% of Swiss GDP). But matters started to complicate when the EU announced its own Quantiative Easing program and the Russian ruble collapsed.
With the large balance sheet of the SNB and the QE program as a backdrop, sophomore and member of Stern Quantitative Finance Society’s Global Macro portfolio team, Paras Shah, commented, “I think it was a smart idea for the SNB to lift the peg.”
He went on to explain that to maintain this peg, the central bank would need to be able to sell their currency and buy foreign currencies in mass.
“It was going to take a massive amount of foreign exchange work to keep the peg in place, and while this may have been possible to continue for the next year or two, it would significantly limit the central bank’s ability to really do anything using hard currency or currency reserves,” said Shah.
In the wake of this action, however, perhaps the real danger is to Switzerland itself. The country now faces the possibility of an economic downturn and deflation due to the rising value of the franc. The bank has further moved towards deeper negative interest rates. The SNB’s new interest rate is now -0.75% a year. In comparison, the ECB is still at -0.2% a year.
So while the initial excitement and uproar following the SNB’s surprise announcement is gone, the numerous effects of this policy change are only now coming into the spotlight. Moving forward, it is important to see how an appreciating Franc will affect both Switzerland and all the countries economically and politically linked to it.