After I wrote my commentary yesterday morning the Swiss National Bank shocked the world when it announced it would remove the cap it had in place to prevent the Swiss Franc from rising too high against the Euro.
Here’s what that means and what it’s all about
Switzerland has a long reputation for having an incredibly stable financial system (everyone knows about its legendary banks). In 2011, during the scariest times for the euro zone, the country’s safe-haven status turned the nation into an island of tranquility. Money poured into it from elsewhere in the euro zone as investors sought a safe place to park their cash. Of course, with everyone wanting to have their money in Switzerland, the Franc exploded in value. In early 2010, one Franc was less than 0.7 Euro. By the middle of 2011 the Franc was nearly at parity against the Euro, a massive move in a very short period.
Countries typically don’t like it when their currencies zoom like that. The most obvious reason is that it’s bad news for domestic exporters whose goods become less competitive abroad. Switzerland is known for its high-value exports, such as watches and pharmaceuticals, so a surging currency isn’t helpful. There are other reasons related to financial-system plumbing that create a problem for a country when a huge slug of foreign cash rushes in.
So in the summer of 2011, the Swiss National Bank announced a cap on the exchange rate between the Euro and the Franc. The Euro wouldn’t be allowed to weaken below 1.20 against the Franc. The bank maintained the cap by printing Francs on a regular basis to buy Euros in the market to ensure that the currencies wouldn’t breach that line. The cap held without a hiccup for more than three years.
So what happened Yesterday?
Without any hint that it was coming, the bank removed the cap, causing the Franc to soar against other currencies. In a statement, the Swiss National Bank explained the move. Essentially, it said that the crisis period of 2011 has passed but it’s clear the Euro is headed for further weakness:
“The minimum exchange rate was introduced during a period of exceptional overvaluation of the Swiss Franc and an extremely high level of uncertainty on the financial markets. This exceptional and temporary measure protected the Swiss economy from serious harm. 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. 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 Euro has depreciated considerably against the US Dollar and this, in turn, has caused the Swiss Franc to weaken against the US Dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.”
In a note to clients, Société Générale currency strategist Kit Juckes explains that the SNB came to the conclusion that it didn’t make sense for it to keep on an endless path of buying more and more Euros just to keep the currency down. And that perhaps the bank felt that all the Euros it was accumulating on its ballooning balance sheet were becoming a liability. Furthermore, the European Central Bank is seemingly on the verge of launching its own Quantitative Easing program, which should put more downward pressure on the Euro and further increase the cost of holding the peg.
But don’t expect the SNB to just do nothing now. Here’s Juckes explaining that now we can simply expect them to change tactics (CHF is the Swiss Franc):
The SNB is not ‘giving up’ but rather, changing tack. After allowing the markets to clear, further intervention is likely—but possibly, in USD/CHF rather than EUR/CHF, with added emphasis on the CHF trade weighted index. After all, the marginal buyer of Swiss luxury goods nowadays is more likely to be in Beijing or Shanghai than Frankfurt or Paris. After that, the SNB will see what the effect of the new interest rate stance is, after all, such deeply negative rates will have an impact on the appetite of anyone to keep money on deposit in Swiss francs. The SNB must hope that the EUR/CHF, after settling at a much lower level initially, then drifts back upwards towards 1.20. A more realistic hope might be that the USD/CHF rate gets back above parity later this year.
So what does it matter to the world?
Well, whenever there are gigantic moves in any market, you can expect that a lot of people just lost a ton of money. There are other big ramifications in eastern European countries, where many people have mortgages denominated in francs. Those mortgages just got a LOT more expensive. This shocker comes at a time when financial markets are experiencing a level of volatility not seen in a while. The collapse in commodities has already caused lots of pain. Now there’s another out-of-the-blue move to add stress to the system.
The SNB move sparked mayhem on trading floors and increased speculation that the European Central Bank may unveil a broader program of stimulus when it meets next week. FXCM Inc., the largest U.S. retail foreign-exchange brokerage, said it may have breached some capital requirements after clients got caught out by the Franc surge, while a New Zealand currency brokerage said it would close due to losses. The Euro area reports final December consumer prices figures today.
This morning on the economic front we have Euro-Zone and German CPI at 10.00 am and 1.00 pm respectively. This is followed at 2.15 pm by US Industrial Production. At 3.00 pm we have the University of Michigan Consumer Confidence. Finally at the very late time of 9.00 pm we have the Net Long Term TIC Flows.
March S&P 500
The extraordinary volatility in all markets continued yesterday. The volatility was enhanced by the totally unexpected move by the SNB to remove the Swiss Cap against the Euro. Thankfully I do not trade the Swiss currency as yesterday’s surprise move has put many trading firms and individual traders sadly out of business. Just before I posted yesterday morning we had the SNB news and by the time I posted the S&P was trading at my 1996 buy level. Luckily the plan worked out well as shortly after the US markets opened the S&P had a nice rally which enabled me to cover this position at 2006 and I am now flat. The S&P got hit hard again into the close and that theme continued overnight with the market trading as low as 1970 at 2 am before recovering to 1986 presently.
There is no doubt that the strong Dollar is causing mayhem in the markets and with no sign of the Dollar bottoming, this volatility is here to stay. The fact that the S&P managed to close again below the 2016 key pivot point has to be respected and today I will lower my sell level to 2002/2008 with a wider 2017 stop. The 1962/1970 area is good support and I will also be a buyer if we test this level again with a 1955 stop.
Euro/USD
Luckily by the time I posted yesterday morning the Euro was already well below my buy level and stop. There is no doubt that after yesterday’s surprise move by the SNB, that next Thursday’s ECB Meeting is shaping up to be one of the key events of the year. How the ECB is going to buy Sovereign Bonds at these crazily low levels will be very interesting. The Euro is currently unloved and trading at the bottom of both its Bollinger Band and Williams Index. The 14 day RSI is very oversold with a reading of just 19. Today I will be a small buyer from 1.1590/1.1625 with a 1.1550 stop which is just below yesterday’s spike lower.
US Dollar Index
By the time I posted yesterday morning I was stopped out of my 92.70 short position at 92.50. The Dollar subsequently rallied to my 92.80 sell level at lunch time. I am still short and I will leave my stop the same at 93.40.
March DAX
The widening divergence between the US stock markets and the Dax continues unabated as every dip in the DAX is been bought aggressively by the market. By the time I posted yesterday morning I was stopped out of the rest of my 9780 long position at 9850. The Dax was trading at my 9760 buy level shortly after I posted and after a huge rally back to the 10000 level I was able to cover this position at 9930 and I am now flat. The DAX is trading very near its contract highs of last Summer and the price action is very clearly telling me not to be short this market at this time. Today I will again be a small buyer on any dip to 9880/9930 with a 9840 stop.
March FTSE
The FTSE plan also worked out very well yesterday as by the time I posted the market was trading at my 6320 buy level. Subsequently the FTSE had a very nice rally which enabled me to cover this position at 6400 and I am now flat. Just like the Dax above the price action in the FTSE is telling you not to be short the market at this time. Today I will again be a small buyer on any dip to 6360/6390 with a 6325 stop.
Dow Rolling Contract
The incredible volatility in the Dow continues with the market moving in another 400 point range over the last 24 hours. Given how well bid the European Indices are trading, it makes it very difficult for me to go short the Dow and today I will be a small buyer on any dip to 17210/17260 with a 17160 stop which is just above the overnight low.
March BUND
With yesterday’s surprise SNB move I was very quickly stopped out of my 157.30 short position for a small loss at 157.50 and I am now flat. Incredibly the Bund is now trading at new highs at 158.00 and if we keep progressing at this pace we will soon have negative interest rates in the 10 year German Bund. Today I will again be a small seller from 158.20/158.60 with a 158.80 stop.
Gold Rolling Contract
As expected, Gold has had a very nice rally so far in 2015 with the market at one stage trading over 1275. I am still flat and today I will move my buy level higher to 1242/1250 with a 1235 stop.
Silver Rolling Contract
Silver continues to underperform the Gold market at this time. I am still long at at 16.30 and today I will raise my stop on this position to 16.60.
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