Market Commentary - February 2015 - Swiss Cheese

When most people think of Switzerland it brings up thoughts of chocolate, skiing, cheese, watches and....bank accounts. Earlier this month the Swiss National Bank stunned the world by announcing they would be canceling its policy of capping the Swiss franc at 1.20 to the Euro. This cap was initially put in place to prevent the Swiss franc from rising too high against the euro. This is significant for many reasons and could have some troubling ripple effects to the global economy.

First, a little history. Switzerland has long been known as a stable economy and considered a safe-haven for investors. During the 2011 European banking crisis investors fled the Euro and piled into Swiss francs as they feared the euro was on the verge of falling apart. This lead to a sharp appreciation in the franc in a very short period of time. Most countries aim to limit the volatility in their currency to avoid extreme economic shocks. Along those lines, they also aim to keep their currencies from rising too quickly as it hurts their domestic exports. Their goods and services become less competitive.

In the summer of 2011, the Swiss National bank announced a max cap on the exchange rate between the Swiss franc and the Euro in an attempt to keep the franc from appreciating too quickly. The decision by the Swiss National bank appeared to be a wise decision and sort of shielded them from any potential "currency wars".

Earlier this month the cap was removed without any warning. No one saw it coming and caused the franc to soar nearly 30% after the announcement. The Swiss government claims their currency is no longer overvalued and the cap was put in place when there was a high level of uncertainty in the financial markets in 2011. While this is true, many are wondering if this move by the Swiss government was an attempt for them to distance themselves from the Euro and if they are questioning the sustainability of the Euro given the large debt levels many of the countries in the European Union carry. The Swiss had to keep purchasing more and more euros to keep the franc price down and it could be the Swiss government did not want to hold too many Euros on their balance sheet.

The bigger picture concern is if other countries follow suit. This could lead to wild swings in many already weak European countries. The Euro has been dropping in value since June 2014 and it appears there is no immediate end in sight. The benefactor of this has been the U.S. dollar. While a strong dollar has its positives, there are some concerns here. If the dollar becomes too strong over a short period of time, it potentially hurts US exports. With many countries attempting to debase (devalue) their own currency, there are worries that "currency wars" could break out and leave some already crippled economies in worse shape.

Only the Swiss Bank knows the true reason why they shocked the world but I find it hard to believe it was only for the reasons they gave.