New York Times: Swiss Franc Soars After Central Bank Drops Cap

 

 

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In Geneva, lines formed outside a currency exchange office. Credit Martial Trezzini/European Pressphoto Agency

 

PARIS – Switzerland stunned the markets on Thursday by abandoning a crucial part of its effort to hold down the value of its currency, concluding that the strategy was too risky and too costly given the enormous forces pushing in the other direction.

The move underscores the turbulent state of the global economy. Around the world, smaller economies are grappling with how to navigate the aggressive monetary activism of major central banks like the Federal Reserve in the United States and the European Central Bank.

The Swiss central bank had been trying to cap the value of its currency, the franc, against the euro, with nervous investors fleeing the market tumult and seeking the relative safety of Switzerland. But the euro’s decline has been particularly steep – and the rout may accelerate.

The European Central Bank is expected to announce a major new stimulus program next week to pump money into the region’s troubled economy, which is creating downward pressure on the euro. That pressure is particularly marked against the dollar, which is rising in part because of a strong United States economy and plans by the Fed to raise interest rates.

If the Europeans undertake such an effort, it would make it that much more expensive for the Swiss to buy enough euros to maintain the value of the franc. So the Swiss leaders’ abandonment of its target was taken as a bet that easier money from the European Central Bank is on the way, and potentially on a vast scale.

“Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced,” the Swiss central bank said in the announcement.

The abrupt decision on Thursday sent the value of the Swiss franc soaring, as the country’s stocks broadly plummeted. The shares of exporters, in particular, got slammed over fears that the rising currency would weigh on profit.

“Words fail me!” Nick Hayek, the chief executive of the Swiss watchmaker the Swatch Group, said in a statement distributed to news media, adding that today’s action “is a tsunami: for the export industry and for tourism, and finally for the entire country.”

The move hit some traders especially hard. FXCM, an online currency trading house based in New York City, said that the “unprecedented volatility” had led to significant losses by clients. The company said it had a negative equity balance of about $225 million. As a result, FXCM said it “may be in breach of some regulatory capital requirements.”

 

The Swiss policy dates to September 2011, near the height of the sovereign debt crisis in Europe.

As panic set in, investors and savers dumped euros in favor of the Swiss franc and other safe havens. The rising value of the Swiss franc, however, could contribute to pushing the country into deflation and create problems for the country’s exporters, which suddenly found their products less competitive overseas. Switzerland’s economy is heavily dependent on such companies.

So the Swiss monetary authorities instituted a policy to try to keep the euro to a floor of 1.20 francs. Only last month, it reiterated a pledge to continue to support that floor by buying the euro in “unlimited quantities” if needed.

The Swiss central bank’s strategy, which involves selling francs on the open market in exchange for euros, has been controversial at home. Many exporters had welcomed the decision to hold down the franc.

But as the central bank’s balance sheet grew by several hundred billion euros, the central bank came under fire from opponents. In a December referendum, those critics tried to force the central bank to convert much of its foreign exchange holdings into gold. That initiative failed.

 

On Thursday, the central bank surrendered to the market dynamics, saying in a statement that it was giving up the minimum exchange rate.

“This exceptional and temporary measure protected the Swiss economy from serious harm,” the central bank said in a statement. “While the Swiss franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate. The economy was able to take advantage of this phase to adjust to the new situation.”

Phyllis Papadavid, foreign exchange strategist at BNP Paribas in London, said after the Swiss central bank action that monetary authorities were “still sensitive” to the overvaluation of the franc, but that they had adapted to changed conditions – particularly the dollar’s recent rise – by changing course.

“They haven’t given up,” Ms. Papadavid said. “They’re clearly going to continue watching it.”

As it scrapped the cap, the Swiss central bank simultaneously cut interest rates, already in negative terrain, hoping to offset some of the damage in foreign exchange markets. It changed the rate on deposits to minus 0.75 percent from minus 0.25 percent, tripling what it costs lenders to park money at the central bank.

But that was too little to stop the tide, and the franc jolted 15 percent higher against the euro. Swiss stocks plummeted in value as investors hastened to sell equities priced in francs.

Shares of Swatch, the global watch brand, fell 16 percent, leading the Swiss Market Index nearly 9 percent lower. But the decline was broad-based, including Nestlé, the food manufacturer; Holcim, the giant cement maker; and the chemical company Syngenta.

“We can only guess at what was in their minds,” Carl B. Weinberg, chief global economist at High Frequency Economics, said of the Swiss central bank’s move. “Maybe they are afraid that the euro is coming on some hard times, and they didn’t want to be tied to a sinking ship.”

Mr. Weinberg said it was hard at the moment to tell what the fallout would ultimately be, but that it would mainly be “micro effects, rather than macro effects.”

“A lot of people were borrowing in Swiss francs because they were cheap,” Mr. Weinberg said. “Well, anyone who borrowed in francs now owes something like 15 percent more than they did yesterday.”

“But anyone who has Swiss assets is a little bit richer today,” he added. “Net, there are winners and losers.”

David Jolly reported from Paris and Neil Irwin from Washington.