The immediate cause of the Swiss National Bank's surprise elimination of its three year old euro peg for the franc this morning was the 17 percent collapse of the euro against the dollar since early last summer.
Defending the 1.2000 francs per euro peg in the currency markets by buying euros and selling francs when a weaker euro was actively sought by the European Central Bank had become untenable.
Maintaining the fixed value of the franc forced the SNB to accumulate euros at a rate that was threatening to warp its balance sheet and the pace was likely to accelerate as the ECB moves into full-fledged quantitative easing.
In the SNB's own words, "Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced. 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."
The SNB had given no hint that it was contemplating such a policy reversal. As recently as three days ago SNB officials had affirmed that the bank was keeping the peg.
Some idea of the amount of pressure that had been applied by the markets against the peg and contained by the central bank is provided by the extraordinary volatility that followed the 4:30 am New York time announcement.
The eur/chf plummeted 35 figures from 1.20009 at 4:30 am to 0.85172 at 4:49 am, sending the franc as much as a record 41 percent higher against the united currency.
The dollar/swiss plunged 28 figures from 1.0221 to 0.7406 in 18 minutes, briefly adding 38 percent to its value versus the dollar.
The euro dropped from 1.1752 to 1.1575 versus the dollar, a modest figure and three-quarters, 1.5 percent, as the bulk of the cross generated volatility was absorbed by the franc itself.
Stop loss selling orders flooded bank trading desks and for many minutes it was difficult to find a price let alone a bid in the cross or the dollar/chf. Several electronic platforms including those of Deutsche Bank and Forex.com suspended trading briefly according to Bloomberg.com. For almost an hour it was very difficult to trade the cross or the dollar/swiss in the non-existent liquidity.
By the close of trading the eur/chf and dollar/swiss had recovered roughly half their losses, ending at 1.00314, down 16.5 percent and 0.8631, 15.3 percent lower, respectively. The euro remained lower at 1.1622.
In an accompanying move, the Swiss National Bank cuts it Libor target rate by 50 basis points to -0.75 percent. The central bank now charges commercial banks 0.75 percent when they keep funds on deposit.
In the bond market, Swiss government bonds pay negative yields on any securities with maturities of nine years or less. German, Italian French and Spanish sovereign yields are negative at five years or less.
Disinflation and the threat of deflation are stalking many of the world's developed economics.
In the past five years, Swiss consumer prices have fallen by an average of 0.1 percent, partially due to the strength of the franc which made imported goods cheaper.
The annual consumer price index in the eurozone slipped to -0.2 percent in December, the first non-recessionary deflation reading in its history. Japan has struggled with deflation on and off for 20 years. Even the United States, the inventor of quantitative easing, saw its CPI rate sink to 1.3 percent in November, with 0.7 percent annually predicted for December.
The 56 percent collapse in the price of crude oil since last summer, from $107.26 to its close today at $46.25, will add to the deflationary currents in the world economy. These are pressures that central banks cannot ignore, particularly in their potential impact on consumer spending. That is true even if, as with the U.S. Federal Reserve, they choose to discount energy costs in their official inflation figures.
Has the SNB given up defending its currency from over appreciation? Probably not. What the SNB has done is give the markets time to clear out the pressures that had been building against the euro peg and to wait out the effect of the likely ECB sovereign purchase program on the euro before attempting to regain control of its currency.
Chief Market Strategist
WorldWideMarkets Online Trading