The Race For The Bottom: ECB Beats SNB

It must be something in the water, or maybe in the chocolate.

The Swiss National Bank shocked markets on January 15th, suddenly lifting a cap on the value of that country’s currency vis-à-vis the euro, a cap it had defended since September 2011.

Indeed, this seemed to some to be a rare case when a central bank’s interventionist policy worked. The cap, imposed originally after an alarming fall in the value of the euro versus the CHF. From a high of 1.68 in 2007 to a low near parity just before the SNB announced it would intervene, resulted in impressively stable looking exchange rate charts. The charts for the period 2012-2014 show a somewhat jagged line at the start, as traders repeatedly press the CHF against the cap and as the bank as repeatedly defends it.

But by the beginning of 2014 at the latest, the line flattens out considerable. The resolve of the SNB, and its possession of the tools necessary to enforce its policy, evidently impressed traders and challenges to the cap died away.

On January 15, 2015, on the other hand, traders immediately bid the value of the franc up, dramatically. More than that, they caused a stunning though brief bubble in the value of oil. The right-hand side of the chart above indicates that oil was selling at $47.50 a barrel just before the SNB announcement, and almost $51 soon after, before it quickly subsided back to the neighborhood of $48.

Eric Scott Hunsader of Nanex, tweeting, called this (and the inverse move in world equities) a “world-wide flash crash.”

Renewed Warnings

The wild moves of a number of prices in the wake of the SNB announcement immediately produced renewed warnings about high-frequency and algorithmic trading. The thought behind such warnings is that a calming human influence needs a chance to intervene upon such an event, or else our machines will get carried away. I’m not sure I really accept that. There are reasons to be concerned about HFT, as I hope I’ve made clear on this blog in the recent past, for example here, or here, but I don’t believe that this event really adds much weight to that case.

Still, the lifting of the cap will have a number of not-so-flashy consequences, for example by empowering tourists with their savings in CHF to shop ‘til they drop in Paris or Milan with the benefit of the newly-favorable exchange rate. On the other hand, it may prove a devastating blow to Swiss exporters, for whose benefit the cap was conceived and maintained.

But for some one key question has to be: why? Why the sudden change in policy, and why now? Does this tell investors and traders something they need to know about the thinking of those central bankers going forward?

There has long been a good deal of internal political opposition to the SNB’s policy. This was reflected in a referendum campaign last year. Petitioners forced a vote on a measure that would have required the SNB to increase its gold reserve from 7.7% to 20%. That increase would have cramped the bank’s ability to maintain its EUR/CHF cap, which was at least part of the point.

The “no” vote won, though, so the SNB had the go-ahead to continue with its policy. Yet it won’t. Why not?

The ECB Wins the Race

The short answer is that the ECB and the SNB have together engaged in a classic “race to the bottom,” and the ECB has won. The eurozone has been aggressively weakening its own currency against, say, the U.S. dollar or the British pound.

In mid-January of 2014, a U.S. dollar was worth roughly .73 of a euro. By January 10, 2015, the dollar was worth 0.84 of a euro. Thereafter, the ECB has gotten even more aggressive at the expense of its currency’s value, and has even received legal back-up, an opinion of the Advocate-General to the European Court of Justice, that a 2012 bond-buying blueprint is not in violation of EU law. That opinion wasn’t much of a shock, but it was a rebuff to those stiff-necked austerity-worshipping Germans and a pat on the back for the quantitative easers.

That may have been, for the Swiss, the last straw. The eurozone is weakening its own currency in too determined a fashion, at too rapid a rate, and the Swiss won’t buy stability at the cost of preserving a tie to that policy.