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Seed Weekly - Swiss Franc Volatility ? A Precursor for 2015?

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Seed Weekly - Swiss Franc Volatility – A Precursor for 2015?

Volatility is the up and down movement of the price of an asset, usually a stock price, but it also extends to changes in the exchange rate of one currency against another.

Typically the volatility of developed-world currencies has been reasonably low. However, this is not necessarily the case for emerging markets, with South African investors and businessmen having first-hand experience of just how volatile the Rand’s rate of exchange with global currencies can be. For example, in 2001 the rand opened at around R7.65/USD, but depreciated sharply to end that year at over R12/USD.

Other currencies that have experienced high levels of volatility include:
• In December 1994 increased US interest rates help spark the Mexican Peso to a loss of over 50% against the USD.
• The Thailand central bank devalued its currency and this saw the Thai Baht fell 48% against the USD in 1997.
• Argentina tried to maintain a one to one peg of its peso to the USD, but was forced to default on US denominated debt and in June 2002 the peso fell 74% against the USD.
• In December 2014 the Russian Ruble fell 34% against the USD as the Russian economy plunged towards recession on the back of the massive decline in oil prices and hence lower exports.

Last week one of the world’s strongest currencies, the Swiss franc had a taste of the type of volatility normally found only in emerging market currencies – but to the upside. In one day the Swiss franc appreciated by 17% against the euro – one of the biggest movements ever in the currency markets.

The Swiss central bank (the Swiss National Bank or SN, in an attempt to curtail currency strength, had over the last 3 years tried to maintain the franc pegged to the euro at 1.2 Swiss francs. Because 70% of the Swiss economy is export driven and roughly half of this is to the Eurozone, a strong franc negatively impacts this exporting economy. At the same time the Swiss economy has been in deflation since 2012.

The SNB kept the Swiss franc from firming against the euro by using an unlimited quantity of Swiss francs to buy euros from the banking system. In order to buy euros it had to print Swiss francs and the SNB expanded its balance sheet from around CHF 75bn to CHF 380bn at the end of November2014 as it bought up euros.

As the chart below reflects, it had been successful in that the exchange rate was maintained at close to 1.2 CHF to the euro, but it has come at a huge cost in terms of the rapid snap back of the currency that was being artificially restrained.

With the European Central Bank about to announce a major stimulus package in the form of euro printing this week, the SNB acted to stop supporting the peg. This immediately saw the Swiss currency appreciate from 1.2 to close to parity to the euro. Because of the negative impact on the Swiss economy, the Swiss market immediately fell 10%. Even negative yields on 10 year government bonds have not been low enough to dissuade money flows to the Swiss franc.

The extent of a move such as this is a timely reminder that where there is low volatility, even over a 3 year period, one cannot necessarily bank on this continuing especially where there is an “artificial” buyer (or seller) of last resort in the form of a central bank. The rapid appreciation of this currency is a timely reminder that investors will need to be vigilant in the year ahead and not take any price quoted yesterday as a reasonable anchor for future prices.

Regards,

Ian de Lange

www.seedinvestments.co.za
info@seedinvestments.co.za
021 914 4966

Tue, 20 Jan 2015

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