We all know that the U.S. dollar changes value relative to other currencies. However, early last week, $10 was equal to about 10 Swiss Francs. Today, you would only get about 8.5 Francs for a U.S. $10 bill. Does this sudden change matter to investors?
The Swiss National Bank (SNB) has a role similar to our Federal Reserve. Last week, SNB announced they were abandoning the currency “peg” they have employed for over three and a half years. The news caused the Swiss Franc to gain significant value relative to most other currencies in the world, including the U.S. Dollar and the Euro, in one day. During this coming week, the news media will likely carry reports from currency traders and hedge funds regarding the investment impact of this news. What’s the background and what does the future hold?
Why is Switzerland’s Currency Important?
The Swiss currency, the Franc, is considered to be a safe haven currency. This means investors are comfortable owning it in times of increased market and economic volatility as they believe it will continue to maintain its value over other currencies they could hold. As a currency owner you are concerned about two things; 1) inflation eating away the value of your currency (as inflation increases, it takes more Francs to buy the same product) and 2) the fiscal soundness of the government/economy that backs the currency. Switzerland has a long history of low inflation and economic stability.The Swiss Peg
Let’s go back a few years to better understand this situation. In 2011, the big issue was the Greek economy. If Greece went bankrupt, it may have forced other bigger European countries, such as Spain and Italy, to do the same. There were also concerns that the European Union would be broken up. The Euro, which is the currency used by the European Union, was under significant pressure as owners were concerned the currency would experience a quick devaluation. Many citizens and investors switched their currency holdings from the Euro to the Swiss Franc, which was considered both safe and stable.As more people converted their currency to the Swiss Franc, the value of the Franc went up significantly, meaning an investor received less Francs per Euro. Intuitively, you may think a higher value is good. However, not in this case, as a swift and significant rise in a country’s currency will put major strains on their economy. All Swiss companies quickly became less competitive as their goods became more expensive to produce and sell compared to their non-Swiss peers.
The Swiss National Bank decided to begin a program to help stabilize the value of their currency and to keep it from appreciating. This is referred to as a “peg”, which results in a currency being pegged at a certain value with the goal of maintaining that value. In this case, Switzerland was willing to buy Euros and sell their Francs, as much as needed, to keep their currency from rising further. If you relate this to “supply and demand”, by purchasing Euros, the SNB was pushing up the value of the Euro. Likewise, by putting more Francs into the economy, the value of Francs went down.
Fast Forward to Today
After years of buying Euros to keep the peg in place, the SNB decided to abandon this policy. They will instead move to enact “negative interest” rates to dissuade continued buying of the Swiss Franc. What’s the impact? Owners of Swiss Francs will lose money each month as they continue to hold the currency. To clarify: If you put $100 in a savings account and the bank pays you a negative two percent interest, in one year, you would only have $98. The SNB made this move without warning and caught the world by surprise. Many speculate the move was made now due to next week’s European Central Bank (ECB) meeting. At this meeting, it is widely believed that the ECB will announce a significant bond buying program to help boost the European economy. If this move happens more Euros will be put into public hands as bonds are purchased. This is similar to the Quantitative Easing strategy used by our Federal Reserve since 2009. This would likely devalue the Euro, which in turn will increase the value of the Swiss Franc. Believing this, the SNB may have felt they were fighting a losing battle and needed to change their strategy.