Dear PGM Capital Blog readers,
On Thursday, January 15, the Swiss National Bank (SNB) roiled markets worldwide with its unexpected decision to abandon the Swiss franc’s cap against the Euro. The news of the repeal of the minimum Euro exchange rate against the Swiss franc hit the financial markets like a bomb.
As can be seen from below chart, the Euro fell almost 19 percent against the Swiss franc in a chaotic trade after the central bank abandoned the cap on the currency’s value against the euro.
Following the SNB move the euro went from buying 1.20 francs to buying just 0.805, to close the week at 0.9927 as can be seen from above chart.
In a statement the Swiss National Bank (SNB) said the cap, introduced in September 2011, was no longer justified.
It also cut a key interest rate from -0.25% to -0.75%, raising the amount investors pay to hold Swiss deposits.
The International Monetary Fund’s head, Christine Lagarde, called the move “a bit of a surprise”.
She said she was also surprised that the governor of the Swiss National Bank had not contacted her, and said she hoped he had communicated the plan to his fellow central bank governors.
MARKETS REACTION:
The SNB decision roiled markets around the world. U.S. 10-year Treasuries erased declines, pushing yields down as much as 16 basis points, or 0.16 percentage point, to 1.7 percent. The yield on German two-year notes dropped to a record minus 0.154 percent.
As can be seen from above chart, the Swiss SMI, closed the week at 7,899.94 a loss of 1,350.06 points or 14.595 percent for the week, its biggest weekly decline since 1988.
As a reaction to the news, stock markets in Europe initially fell but then rallied, with the Euro Stoxx index rising 2.2 per cent. On the other hand stocks in the USA were down, on Thursday, January 15, USA stocks rallied on Friday but ended the week in the red.
Gold, Silver proved themselves again as the ultimate safe haven in times of turmoil.
As can be seen from below chart, Gold soared from US$ 1225.00 per Troy Ounce before the SNB announcement to close the week on Friday January 16 at US$ 1,279.34, an increase of US$ 54.34 or 4.435 percent.
Silver did it even better, poor man’s gold went from US$ 16.70 an oz, on Thursday, January 15 at approx. 10:o0 am to close the week on Friday, January 16, at US$ 17.77, an appreciation of US$ 1.07 or 6.4 percent as can be seen from below chart.
As can be seen from below charts as a consequence the Swiss Franc appreciated for the week, with respectively 20.93 percent against the Euro and 18.52 percent to close the week at respectively Euro 1.0074 and US$ 1.1646 for one Swiss Franc (CHF), its highest level since August 2011.
Based on the above, it means that measured in Euro’s as well as in US-Dollars, the Swiss Stockmarket (SIX) -which is measured in Swiss Francs – has appreciated with respectively 6.33 percent and 3.93 percent since the announcement of SNB of last Thursday, January 15, 2015.
WHY DID THE SWISS UNCAP THE FRANC:
The SNB introduced a cap on the Swiss franc against the euro in September 2011, to insulate the country, a traditional financial safe-haven, from the euro zone’s sovereign-debt crisis. It wanted to prevent the franc from appreciating too strongly against the euro, which would have hampered exports and contributed to deflation.
Thomas J. Jordan, Chairman of the Governing Board, SNB
Strong demand for the franc as a safe-haven has persisted due to the possibility that Greece could exit the euro zone. To cap the franc, the SNB accumulated large foreign currency reserves amounting to approximately 70% of Swiss GDP (about CHF 500 billion) – 45% of which was denominated in euros.
The central bank invested their euro purchases thereafter in bonds and equities, and spread these systems over other currencies. Consequently, it earned with its gigantic foreign exchange reserves last year alone, a record sum of 38 billion francs.
PGM CAPITAL COMMENTS:
The announcement of the SNB of last Thursday, came in response to possible new stimulus measures by the European Central Bank (ECB). The ECB could decide to start buying government bonds (i.e., quantitative easing) during their meeting of coming Thursday January 22nd, to help bolster faltering euro zone economies. This move by the ECB, consistent with the broader goal of expanding its balance sheet by about 1 trillion Euros, would add further downward pressure on the euro, exposing the SNB to potentially large valuation losses on its euro-denominated reserves.
Maintaining a cap on the franc would have required the SNB to continue buying euros, further increasing its exposure to potential losses.
Below figure shows the effects of the cap on the Swiss Economy.
Due to the announcement of the SNB, one of the world’s safest investments, the Swiss franc, swung wildly last week. Holders of Swiss francs profited handsomely, but many investors and brokerage firms with a short position on the Swiss franc were pounded with huge losses, for which two brokerage firms in London and New Zealand announced that they would have to close.
Most investors will be asking themselves if the removal of the cap on Swiss franc, of last Thursday has caused such a turmoil in the markets, what might the consequences be if China stopped pegging the Yuan to the US-Dollar.
As a consequence of the pegging and to ensure the relative value, there is heavy buying by China of the US-Dollar, which may also been seen as debt financing for the US. This is giving the USA a major immediate respite from their tricky financial condition and allowing the economy to run without taking too many hard decisions.
After unpegging the Yuan from the US-Dollar, prices of both Chinese as well domestically in the USA produced goods, will rise, which means that unpegging from the dollar might not have a negative impact on Chinese exports to the USA. On the other hand, after unpegging, the need for China to maintain large dollar reserves would end, leading to lower demand for dollar. With decreased demand of the dollar, prices and interest rates in USA would increase. This will lead to a reduced borrowing and lower flow of credit into USA, leading to a possible severe credit crunch.
So if the Swiss Bazooka, has such dramatic consequences for the markets, beware of the Chinese Bazooka.
We believe that it isn’t IF, but just a question of TIME before China, currently world’s second biggest economy, also demands a bigger role for their Yuan in the World and when that happens it might be the end of the US-Dollar.
The lessons investors should have learned from last Thursday January 15th is, that Gold, Silver and other precious metals are the ultimate safe haven in time of uncertainties.
Due to this we believe that the smart money will continue to accumulate Gold as an insurance.
Until next week.
Yours sincerely,
Eric Panneflek