Last week, the Swiss National Bank abandoned its attempt to tie the Swiss franc to the euro. For the past three years, the SNB has been trying to keep the franc from appreciating relative to the rest of Europe by accumulating euros and issuing francs. As the size of Switzerland’s foreign exchange holdings began to spiral out of control, Switzerland finally pulled the plug. The Swiss franc immediately soared by 49% (from 0.83 euros/franc to 1.24 euros/franc), but later stabilized to about 1 euro/franc. While numerous motives have been attributed to the Swiss National Bank, the SNB made its reasons clear: "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 effect, the SNB simply did what the German Bundesbank wishes it could do: abandon the policies of European Central Bank president Mario Draghi, and the euro printing inclinations he embraces.
A quick update on what we call our "joint parity" estimates of currency valuation (see our recent discussion of the Japanese yen in Iceberg at the Starboard Bow). Considering long-term purchasing power parity (which certainly does not hold in the short-run) jointly with interest rate parity (see Valuing Foreign Currencies), we presently estimate reasonable valuations of about $1.35 for the euro, and about $1.13 for the Swiss Franc - so after the wild currency moves of last week, we suddenly view the Swissie to be almost precisely where we think it should be relative to the dollar. At least one hedge fund and a number of FX brokerages were wiped out last week as their customers were caught with leveraged short positions against the franc. Data from the CME shows asset managers and leveraged money heavily short the euro (with commercial dealers on the other side), and by our estimates, the decline in the euro is overextended. That's a high-risk combination for euro shorts. Continue Reading »