Switzerland’s line in the sand

April 10, 2012

By James Saft

(Reuters) – Things are getting sticky for the Swiss and their franc.

Twice in the past week the market, that nebulous but inexorable force, took a run at the cap on the value of the franc established by the Swiss National Bank last September.

Last Thursday, amid low pre-holiday volume, the franc actually pierced the 1.20 per euro line the Swiss central bank had drawn in the sand. Suspected intervention soon drove the franc lower but then once again over the weekend the franc came within a hairsbreadth of that line.

“We won’t accept any exchange rate below 1.20. We are committed to buying foreign exchange in unlimited quantities to defend this level,” a spokesman for the SNB said, re-enunciating a policy intended to insulate Swiss exporters and fend off deflation.

“Unlimited” is a lot, as they say in the backwoods, but it is an undertaking that depends not on the SNB’s ability to create francs – they after all have a printing press – but rather on its nerve to continue doing so no matter how painful and apparently risky that operation becomes.

While some suspect that the line was only pierced through small trades with banks which are, for bureaucratic reasons, not parties to standing-order credit arrangements with the SNB, the fact remains that the market loves a target and sees a big fat one.

The issue really isn’t how the trades got through the supposed barrier, but why traders were willing to go so close to it even though they knew it should be there.

They did so for two reasons, one contributory and mostly Swiss and one major one that is entirely euro zone. Since the policy is intended to keep deflation at bay – after all local prices of imported goods fall as the franc strengthens – news of a bit of Swiss inflation last week perhaps gave traders courage. Swiss consumer prices rose 0.6 percent in March from February. Switzerland also has a track record of rowing back on market-bucking and expensive policies, something that perhaps makes investors more aggressive. It may not help that the SNB is now helmed by an interim chairman, Thomas Jordan, who has been caretaker since Phillipp Hildebrand was forced to step down in January when his wife was found to be speculating on the franc.


The fundamental reason for franc strength, though, is really concern about the euro zone and a growing, but still minority, view that the measures taken near the turn of the year to bring debt markets in line simply won’t be enough.

Doubts that Spain will be able to reach its budget goals were fanned last week when Prime Minister Mariano Rajoy warned it faced “extreme difficulty” and may need an international bailout. The yield on 10-year Spanish bonds rose by about 8 percent in the past week to 5.76 percent. Italy too is under the microscope and its funding costs have risen sharply in recent days.

Though the SNB drew its line for domestic reasons, in doing so it tied its fate and that of Switzerland even more closely to the out-turn of events around the euro. People want francs partly because the Swiss economy has been reasonably conservatively managed and is thus robust, but mostly because a franc has the cardinal virtue of not being a euro.

If you are a Greek you may well be worried that at some point in the future your euros will be forcibly exchanged for new drachmas, units that will immediately and sharply fall in value. Holding francs then is simply a bit of insurance. If you are Spanish or Italian and you share the same fear the situation will be exactly the same, except there are more of you and you have far more money.

What Switzerland has done then is to perhaps fend off speculators for a time but leave themselves hugely vulnerable to events. If the fear becomes enough people won’t care about the cap and won’t believe it will hold. While the SNB is supposed to have sold some of the billions in euros it has acquired defending the cap and bought other currencies, they will still face a huge loss if events in the euro zone turn nasty.

Money will come flooding in to take them at their “unlimited” word and the SNB, sooner or later, will decide enough is enough.

This does not have to happen, and maybe it won’t.

The euro zone crisis has demonstrated the great value of a country having a central bank with the remit and freedom to act.

Switzerland’s mistake is in acting as if that power is somehow sovereign to all ills. Central banks, like the rest of us, are hostages to events, all the more if they pretend they are not.

(James Saft is a Reuters columnist. The opinions expressed are his own)

(Editing by James Dalgleish)

(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)

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