EUR/USD recently fell to a fresh two year low at 1.2235. EUR/GBP is well under 0.80, at level last seen in 2008. EUR/JPY is around 11 year lows. UR/AUD ticked below 1.20 – a 23 year low.
Only EUR/CHF is flat at 1.20, without any sign of life, thanks to the effective peg that the Swiss National Bank imposes. How long can they hold the dam on their own? What will happen if it breaks?
Reason for the peg
The goal in keeping the franc at weak level is preventing deflation through falling prices of imported goods. Deflation triggers less consumption, which triggers more prices falls, etc., and is bad for the economy. The move also supports Switzerland’s big export machine – a lower franc keeps prices competitive.
When the peg was introduced in September 2011, EUR/CHF jumped by 10 cents and then fluctuated between 1.20 to 1.24. There was some talk that the SNB would even raise the floor to 1.25, 1.30 or even 1.40.
Bets growing
This seems impossible now. The foreign currency reserves of the SNB already leaped to around 360 billion francs as they needed to print more and more francs in order to buy euros and keep the pair above 1.20.
They are fighting investors who seek the safety of Swiss bonds and the Swiss franc – the ultimate safe haven. They are also fighting the ever worsening bad news coming out of the euro-zone.
In ITC 2012, Ed Ponsi mentioned that it was easier to keep the franc weak and the euro strong while other forces were pushing the euro higher, at calmer times. But now, “the SNB is alone on the bid”.
As the euro crisis deepens, the bets for a rise of the franc are growing and the risk that the SNB is taking is growing with it.
The SNB has a peg to the wrong currency. Can the mass that is shorting EUR/CHF eventually win?
Everybody is asking this question. It seems that as long as the euro slides gradually, the SNB remains on top of the matter. However, a sharper, more violent move could tip the balance. It could come from another deterioration in Spanish banks, a request of help from Italy, a Greek exit, a Finnish exit, a German rejection of the ESM or some other surprising event.
If the SNB is caught off-guard, even for a a short time, it could be overwhelmed without ability to stop the flood. It might also choose to cut its losses.
If the levee breaks, all hell will break loose. The Swiss peg already amassed so much money, that a collapse of this peg will have a strong influence on all euro pairs: EUR/USD could fall hundreds of pips.
What do you think? Will this happen soon?
Further reading: Italian Bailout Coming Soon?
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