The Lowdown on Markets to 16th January 2015
In this week’s issue
- The Swiss National Bank pulls the plug on the euro peg letting the Swiss Franc appreciate.
- It seems that the Swiss Franc has now become the new Deutschemark.
- Amazingly 6 out of the G10 members have short-dated bonds with negative interest rates.
- In the Forex market Alpari UK enters insolvency whilst FXCM receives a cash infusion.
- Gold bullion nudges higher as investors look for “safe haven” protection.
- Whilst volatility rises so do the equity markets of the US and Europe.
What does this mean for the markets and asset classes?
“The Swiss Franc has become the new Deutschemark?”
Prior to the launch of the euro on the 1st January 1999 most Europeans had put their trust in the mighty deutschemark as a hedge against any global crisis. However, since the mark’s demise and its replacement by the single currency Europeans have taken sanctuary in the Swiss Franc in times of uncertainty. Unquestionably, the Swiss Franc had all of the right credentials to become one of the leading safe haven currencies, taking over from the mighty mark, indeed, the franc was regarded as having good currency stability, with a secure source of savings, and an excellent track record as a safe haven hedge against any global crisis.
Clearly by default the Swiss Franc had then become the new German mark, however, when the euro collapsed to parity against the franc in 2011 the Swiss National Bank imposed a peg at SF 1.20 to the euro henceforth stopping any further damage to the Swiss economy. Unfortunately, the Swiss Franc had already appreciated by 40 per cent against the euro since the start of the credit crisis; therefore, giving rise to the view that perhaps the SNB had “shut the stable door after the horse had bolted”.
Then last week, out of the blue, the Swiss National Bank announced that it was going to abandon its current 1.20 cap against the euro, and lowers its interest rate to minus -0.75 per cent. Plainly, this decision by the SNB was not taken as part of a coordinated policy with other central banks, given that Christine Lagarde, head of the International Monetary Fund, said “I find it a bit surprising that he [SNB chairman Thomas Jordon] did not contact me”.
Obviously this came as a huge shock to the markets which saw the Swiss Franc surge against the euro and US dollar, the Swiss 10-year sovereign bond yield fell to minus -2.1 per cent, leaving only Switzerland’s 15-year, 20 year and 30 year paper offering positive yields, however, many European strategists now believe that it won’t be long before negative yields actually extend further along the Swiss yield curve.
Amazingly, six members of the G10 now have shorter-dated bonds with negative interest rates – Germany, Japan, France, Belgium, Netherlands and Switzerland, with only the US, UK, Canada and Italy still offering normal positive returns. This gives you some idea how investors are thinking when they are prepared to pay to lend over a decade. Perhaps it is the threat of deflation and investment volatility that is still pushing investor sentiment towards the short-term safety of government bonds.
In the stock market the Swiss SMI Index fell by minus 14.0 per cent over the week, whilst some of the Swiss exporting company shares saw their prices collapse by more than 20.0 per cent on fears of a stronger franc, owners of Swiss mortgages will undoubtedly suffer as the cost of their repayments rise, whilst British holiday makers traveling to Switzerland will see their costs escalate
However, it was the forex market that suffered the most from the SNB decision as many were on the wrong side of the trade. Broker’s is New York, London, Europe and New Zealand all issued financial warnings. In the UK the likes of Alpari entered insolvency, whilst in New York currency brokerage house FXCM announced that it had secured a US$300 million lifeline from Leucadia National Corp after breaching its capital requirement. Likewise Everest Capital Global Fund was forced to close after racking up heavy losses whilst Comac Capital Hedge Fund and Discovery Capital Management Fund are thought to have suffered heavy losses.
Undeniably, the fallout from the action taken by the Swiss central bank could leave thousands of retail investors that have flocked into currency trading over the years facing some uncertain times given that retail forex brokers have seen rapid growth in this space over recent years which may have left some investors exposed to leveraged positions.
Arguably, what the Swiss authorities have done is to create a financial tsunami burdening the Swiss economy with a strong currency that will undoubtedly affect their many exporting companies and tourism. Clearly, what the Swiss economy really needed was faster growth, more inflation and a turnaround in capital flows; however, what they are likely to see is a slowdown in growth, deflation, and further uncertainty.
Whilst the Swiss National Bank dropped their currency shock last Thursday, it will be this Thursday in Frankfurt that investors will be mindful as the European Central Bank have another opportunity to announce an outright programme of sovereign bond purchases. Indeed, whether the ECB announce a mass bond buying programme or do something unforeseen like getting the National Central Banks to buy the bonds to share the burden will be of immense interest to the market and investors but it is likely to have a positive effect on the markets.
Inevitability, last week’s Swiss actions did see the euro plunge against the franc, dollar and sterling, however less so on a trade weighted basis. Obviously, any announcement this week from Mr Draghi on sovereign bond purchases could see the single currency weaken further, indeed, with this action, and a possible tightening of US interest rates in the not too distant future, it might not be too long before we see the euro reach parity against the US dollar.
Unquestionably, being long the US dollar, and S&P 500 Index, short the euro and Japanese yen has been a very satisfying trade over the past couple of years, as money has flowed back into the world’s reserve currency. Interestingly enough, we have even seen the price of gold bullion nudge higher over recent weeks as global investors became nervous and have looked for a “safe haven asset” to protect themselves against currency fluctuations, economic uncertainties, and unforeseen geo-political crisis.
Elsewhere, there was some better news for the energy sector with oil prices rallying at the end of the week after touching US45.19 earlier in the week, the lowest price since March 2009.Whilst the world’s leading energy forecasters said that an oil price recovery may not be imminent the market is likely to see lower production growth from non-OPEC countries this year. Certainly, the selloff in the oil price is having an impact with exporting countries suffering whilst the importers are benefitting.
Inevitability, if crude oil prices were to remain at their current levels, or indeed drift lower, further positive impacts for the consumer and sectors such as transport and consumer discretionary might be evident through corporate profits and consumer spending.
In the US the latest economic data showed that headline US consumer prices have fallen 0.4 per cent last month, bringing the year-on-year increase down to 0.8 per cent from 1.3 per cent in November. Indeed, core inflation, which excludes food and energy prices, has eased to an annual pace of 1.6 per cent. This latest inflation data along with low wage growth might delay the Federal Reserve Bank in taking any near term action with regards to a rise in interest rates.
Finally, as we head towards the very important events of this week, the European Central Bank’s meeting in Frankfurt, last week’s events have probably taught the us all a valuable lesson, “be wary of Central Banks”, as it was only a few days prior to the withdrawal of the euro cap that the Swiss National Bank said the cap would stay in place?.
Peter Lowman Chief Investment Officer
Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum he worked within larger asset managers, primarily as an Investment Director within Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Investment Committee.
This article does not constitute specific advice and investors should bear in mind that capital invested is not guaranteed.
Investment Quorum is authorised and regulated by the Financial Conduct Authority.