Swiss National Bank: Running In Place From ZIRP to NIRP

There is a saying that the journey is more important than the destination. That saying is particularly true of the Swiss franc that has, in dollar terms, had a wild journey over the past two months; the ride bringing it back within 1.9% of where it stood the day before the peg to the Euro was removed and exactly where it had traded two days before Christmas. This wild ride produced one of the strangest price charts one will ever see [HERE]. On January 15 the Swiss National Bank (SNB) suddenly and without any forewarning abandoned a three year peg of the franc to the Euro at an exchange rate of 1.20:1, thus unleashing a frenzy that had the franc appreciate intraday by as much as 33% before closing the day up 20%.

In foreign exchange markets where fluctuations of 1-2% are seen as extreme this was, in the words of Edward Harrison in Foreign Policy, "...outlandish, a black swan event without precedent." Along the way the SNB lost its reputation for methodical sobriety as well as around CHF 80 billion (equal to 10% of Swiss GDP), British foreign exchange dealer Alpari Group was forced into insolvency, and another firm, FXCM, had to find a $300 million loan to stay afloat.

WAS THERE ANY METHOD TO THE SNB'S MADNESS?

While the SNB deciding to terminate the peg is not hard to understand, the alarm was the abrupt manner in which it did so. Generally central bankers give some guidance to the market, as witnessed in the cottage industry of reading the tea leaves in the pronouncements of the U.S. Federal Reserve. In this case the SNB gave no warning and acted entirely contrary to previous and fairly recent comments on the peg. The speculation that the SNB had to act precipitously in order to cover a short position in gold seems unpersuasive since the franc and gold have moved in tandem for some time and have continued to do so since the removal of the peg. In fact, gold hit its all-time high of $1910 an ounce on September 6, 2011 the very day the peg was put in place.

Another explanation is that the change in policy, but not its abrupt manner, is the SNB essentially providing Quantitative Easing (QE) to the Eurozone through the back door; a practice that would no longer be necessary with the European Central Bank (ECB) preparing to announce its own QE program. A more persuasive explanation is that the prospect of the QE's creation of a trillion new Euros threatened to scuttle the SNB's buying program.

The SNB had reportedly purchased Euros equivalent to 40% of Swiss GDP in just one quarter in 2014 and its balance sheet had swelled to 83% of Swiss GDP by the time the peg was summarily abandoned. This compares to a figure of 26% of U.S. GDP for the Fed that has been following a program of QE most of the time since 2008. As for abruptness, one explanation is that the SNB wanted to send a signal to traders to temper future speculative pressures, but if that was in the case they did so by shooting the Swiss export sector (54% of GDP) in the leg and probably pushing the Swiss economy into recession. The best explanation is that, contrary to the reputation accorded over the centuries to Swiss bankers, the SNB let matters get out of hand and demonstrated some incompetence.

FROM ZIRP TO NIRP TO ?

The SNB did, however, accomplish its primary aim of detaching the franc from the Euro, albeit for a time. After closing down 20% on the day of the surprise announcement, the franc has traded back to (1.07:1) about 11% from the peg. There are unconfirmed reports that the SNB has now adopted an informal peg of 1.05-1.10. It also widened the negative interest rates on Swiss bonds from -0.25% to -0.75% and is rumored to be considering taking those to -1.50. Negative interest rates are another means for pushing down the value of the franc, but are also another form of backdoor support of the ECB as negative interest rates discourage capital flows from the Eurozone (EZ).

On the other hand, the U.S. dollar and U.S. dollar bonds-which pay positive interest rates - are the safe haven du jour. The present rate outlook suggests the U.S. will draw capital from the rest of the world, thus putting some emerging markets in trauma.

All this makes for dangerous times. The world averted a financial collapse after the "Lehman moment" in 2008 through aggressive central bank action. The world economy got hooked on the sugar rush of zero interest rates (ZIRP) and now the previously unimaginable regime of negative interest rates (NIRP). Central banks, as Alice said to the Queen of Hearts, are finding that they, "... must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that." Or, as Edward Harrison cautioned, the unusual SNB erratic action was the "scary canary" in the mine.