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