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Article / 16 January 2015 at 15:01 GMT

Was the SNB's decision a deal with the ECB?

Blogger / MoreLiver's Daily
Finland
  • SNB's surprise decision raises questions
  • The timing just before the upcoming ECB-meeting was not an accident
  • SNB plans to begin unloading its balance sheet to the ECB

By Juhani Huopainen 

A key event in financial history was written yesterday as the Swiss National Bank made a surprise announcement that it would no longer enforce the Swiss franc’s ceiling of 1.20 to the euro. 

The decision will have many effects in the coming months on the global money flows and asset prices, but opinions differ on what exactly the end result will be.
EURCHF
Source: Saxo Trader

SNB as a recycler of European hot money

In 2008, before the financial crisis had begun, the size of the SNB’s balance sheet was CHF100 billion. As the crisis progressed and mutated to the euro crisis, safe haven-flows to the country strengthened the CHF, hurting the competitiveness of Swiss companies, forcing the SNB to lower interest rates, which fed a boom in the real estate market.

The SNB countered this by initiating asset purchases (see graph), which increased the size of its balance sheet to eventually CHF525bn, a total increase of CHF425bn– roughly EUR350bn, when compared to the European Stability Mechanism’s EUR700bn, suggests that the importance of the SNB for the euro area should not be underestimated. The European bond bull market has to some extent been driven by SNB’s purchases.

The balance sheet mirrored the euro crisis perfectly – balance sheet size increased at times of market stress, and remained steady or even decreased after the leaders of the European Union found at least a temporary solution.

The SNB acted as a recycler of European hot money – money that had left the Greek or Spanish banking systems was recycled by the SNB back to European bonds and stocks. The SNB was Europe’s backstop during the crisis.

It was golden – or was it?

The SNB had it all. It created money out of thin air and purchased real assets – foreign currencies, and with those funds, stocks and bonds. Doing so kept the CHF weaker than it would otherwise have been, which was beneficial for the export-oriented economy and kept inflation from going too negative. In effect, the SNB got 425bn by just pressing the “print” button. But something made the SNB stop.

Political reasons: fearing the print

Technically, a central bank can print money as much as it likes. A central bank can spend infinite amounts of money on purchases, and should it later decide to sell some of those assets at a loss, it could always print more money to cover those losses. Thus, a central bank could in theory be completely oblivious to fluctuations in asset prices.

Many people think that this is not the case. They argue that a central bank should for purposes of credibility not expand its balance sheet recklessly and avoid losses from its balance sheet assets. If the central bank would lose credibility, people would perhaps avoid the currency due to increased “risks”.

Political reasons: fearing the voters

Perhaps printing is bad in the real world, even though it is riskless in theory. The central bank could face domestic or foreign political pressure. Domestic voters might be angry that “with their money” questionable government bonds from the euro area are purchased. Last November a referendum was held in Switzerland on whether the SNB would be obliged to hold 20% of its balance sheet in physical gold, and 23% of voters supported it. Perhaps the SNB became scared and realised that there are limits to how and by how much it can expand its balance sheet.

Was Russia an issue?

During the second half of the 2014, the Russian ruble begun to weaken notably, because of cheaper oil and the sanctions. There were large flows from Russia to safe havens and especially Switzerland, which increased the pressure on the EURCHF-peg. Buying Russian assets was probably not a realistic option, so the SNB had to counter by increasing its purchases of European bonds and stocks. After a short pause, the selling pressure on oil and ruble continued, and after only couple of days the SNB made its announcement to abolish the peg. Marc Chandler noted this, asking if the SNB is the only real buyer of the euro.

Were the dismal outlook of assets the issue?

European sovereign bond yields are currently trading at their all-time-lows. It is doubtful there is much room left for the yields to fall, and conversely this means that there is practically no room for the bond prices to rise from here. Perhaps the SNB thought that further purchases of bonds or stocks, which are also near their all-time-highs, would not be a good idea. If the SNB did not see value in further purchases, it might have decided that it would be better to simply let the peg go, in order to avoid adding to a position that was about to become a losing one.

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 The Swiss National Bank had it all. What made it stop? Photo: Thinkstock.com

Did the SNB notice just ECB sitting at the poker table?

Only couple of weeks ago the SNB insisted that the peg is “absolutely necessary”. Obviously, the decision to drop it had been brewing for some time now, and unpegging is not something one could signal over time – it had to be done in an instant.

Next week, on January 22 2015, the European Central Bank’s governing council is widely expected to announce a government bond purchase programme. Maybe the SNB believed that the ECB’s purchasing programme would increase inflation expectations and thus lead to a fall in bond prices and the external value of the EUR.

If the ECB is about to begin asset purchases, the SNB would have a natural buyer for many of the assets it has bought earlier. It is estimated that the ECB’s programme would amount to EUR500bn. That would go a long way in closing out the SNB’s positions. It would suit the SNB perfectly. After buying at lower prices, the SNB could unload most of its holdings to ECB at record prices. The ECB would be left looking like a fool, but the balance sheet would not be SNB’s problem anymore.

Is the SNB trying to help the ECB?

As bond yields are near-zero, the ECB’s purchasing programme would have relatively little effect on the euro area’s economy. It would result in a small transfer to the investors who bought the bonds in anticipation of the ECB’s purchases, but that’s about it. The real effect would come via the currency channel – weaker euro would help the euro area economy much, much more. I think the European version of quantitative easing is actually currency intervention in disguise.

If this is the case, what the ECB desperately needs is to have no natural buyers of euro present. The ECB's bond-purchase plan that depends on a weakening euro requires that the SNB stops responding to the ECB’s every press of the print button by purchasing European assets.

By dropping the peg now, the SNB is able to unload its position to the ECB later, and this sale will help to weaken the euro even more. Sure, this trade is not as sweet to the ECB as it is to the SNB, but it is not by accident that Switzerland got wealthy, and the euro area has become poor.

– Edited by Oliver Morrison

Juhani Huopainen is a blogger and a macro analyst at MoreLiver’s Daily. Follow Juhani or post your comment below to engage with Saxo Bank's social trading platform.
4y
fxtime fxtime
Your last line sums the situation perfectly :-) ''It is not by accident that Switzerland got wealthy''. Interesting comments on the Russian aspect too.
4y
Juhani Huopainen Juhani Huopainen
Many possible reason why the SNB did it.
4y
fxtime fxtime
Very very true....in hindsight it is easy to see they couldn't do nothing and i think they have been rational albeit with the caveat that exports will suffer whilst the CHF currency balances itself over the short term.
4y
Juhani Huopainen Juhani Huopainen
Well, if I was sitting there for couple of years, basically managing Europe's largest hedge fund with a huge beta exposure, and I would see the flows to CHF, and know the amount that one has buy when the EUR weakens...

They've had a long time to think this over. When the situation came up, they acted. It will be interesting to see what will come out of this. Reminds me of the nineties. I miss them.
4y
thewickedwiz thewickedwiz
Don't worry you will relive more than the nineties, this is the first of many dislocations, lets pray the brokers decrease leverage because yesterday was a traffic accident but next time will be a pileup.
Most serious brokers and Saxo have made statements but who else is still in the emergency ward.
This cost a lot in about 3 minutes, what will happen when the second USDJPY move takes place and we go to 150.
4y
fxtime fxtime
There are similarities for the 90's...Russia and LTCM seems peanuts in size to todays ''too big to fail'' behemoths. As for leverage levels that wickedwiz discusses a single contract on usd/chf and a 27% move with the 100:1 leverage FXCM offer is an unbelievable exposure....I note they say a lot of clients funding comes from credit cards !!! So a leveraged deposit to finance leveraged fx accounts. But even the mainstream banks utilise leverage at lower levels....time will tell how good their strategies are if the market ever becomes illiquid like the 90's
4y
thewickedwiz thewickedwiz
well said,its sub prime trading.....
4y
thewickedwiz thewickedwiz
even Saxos comment is a bit lets say opaque....
they have somehow kept the problem in check but will adjust prices...retroactively
I was often refused a price in EUROUSD yesterday for small amounts.
Also IB lost 120 million and they are quite big
This is not the end, but they need to all be more careful!
4y
Juhani Huopainen Juhani Huopainen
I have an old story on a moment when liquidity disappeared for couple of hours in 1991 - read it here: http://morelivers.blogspot.fi/2011/08/moscow-is-not-answering.html
4y
fxtime fxtime
LOL I used to work with those screens too LOL how front desks have changed thankfully....it's a good write up. They were certainly memorable days but rereading it do you not think deja vu?
4y
Juhani Huopainen Juhani Huopainen
All the time! What's the point in experiencing stuff if you don't remember it, and preferably even learn something every once in a while.

Couple of years at any desk will teach quickly the value of optionality, dangers of excessive leverage and the limits of models. And how dangerous back-propagation / curve fitting can be in practice. And the operational risk!
4y
thewickedwiz thewickedwiz
Nice point, was the reason I always vowed only to trade markets in countries with a legal system and liquid markets (that can cease of course in this new reality......)
I had a position of 14 billion in 92 in Bunds and that market was never a problem.
Stick to the core and you can survive.
But what the Swiss did yesterday was worse then when the last SNB guy resigned/left.....
They destroyed trust in a liquid currency and a serious one to date!
4y
thewickedwiz thewickedwiz
off for dinner , have a good weekend
4y
fxtime fxtime
The comment of curve fitting, limits of models, operational risk and VaR is something which should have its own sub heading on this site.
4y
Juhani Huopainen Juhani Huopainen
Perhaps I should write something along those lines, then?
4y
fxtime fxtime
Definately.
We all should perhaps...start a blog along those lines? I always feel sorry for the 90% who lose their accts for a lack of knowledge. Don't start me on curve to fit either grrrrrr. Yet punters still believe in outdated models.
Juhani I envy you....Finland is a great place to live and I haven't been there for many many years. Have a great weekend.
4y
fxtime fxtime
FWIW I searched the WSJ and the FT for references to EW, Fibbos and MACD just for fun as both papers have comment sections and market analysis also they ask other front desks for their current analysis and there is no reference at all from any correspondent of a major bank, fund etc and yet no one considers why these areas are ignored on any trader site no questions if they really are of use or reached a limit of their model !! The only indicator used in mainstream trading is a momo indicator the humble RSI or a major lagging indicator the 200sma the rest (correctly so) is quantified or correlated. This is an area punters here perhaps should become more familiar with as it is far more reliable and profitable imho.
4y
fxtime fxtime
One other pointer might be reference of from month to far month and spread as a guide for punters. Even simple time decay theorem for steady revenue trading on monthly options using std deviations and use of probability....basically showing where high probability revenue streams are as opposed to looking for next short term trade.
4y
fxtime fxtime
grrr I am using my phone to type and clearly the key board is too small for me so sorry for the typos hopefully the posts sort of make sense?

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