Swiss currency shocker 'dwarfs' end of gold standard

In a stark report, world's top money manager PIMCO argues Swiss interest rate move could force individuals and corporations to exit global banking system

Swiss shocker was bigger currency move than end of gold standard

Gold on Friday built on recent gains sparked by Switzerland's central bank's surprise scrapping of the cornerstone of its monetary policy which sent shockwaves through global financial markets already in turmoil as a result of the ripple effects of the collapse in the price of oil and the rampant dollar.

In heavy trade on the New York Mercantile Exchange gold futures jumped to a high of $1,282 an ounce – the highest since end-August and a more than 5% gain for the week. Gold is now trading some $140 above its near four-year low hit early November.

After the Thursday announcement by the Swiss National Bank to end the currency cap, the value of the franc soared 30% as traders tried to figure out the impact on global financial markets. The currency ended the day still almost 20% higher. The SNB also entered other unchartered waters by cutting the interest rate on certain bank deposit account balances to -0.75% – that's minus three-quarters of a percent.

In a new opinion piece from PIMCO – the world's largest investment firm with an eye-watering $1.87 trillion of assets under management – authors Sachin Gupta and Thomas Kressin point out that that the size the franc's intra-day move "may likely dwarf any previous one-day move in a developed market currency going back to ‒ and including ‒ the break of currency pegs against gold under the Bretton Woods system in the 1970s!".

The report titled The Swiss National Bank’s Unpleasant Experience of Sleeping Next to an Elephant makes some salient points about the state of the world's monetary and banking system and the uncertain prospects of central banks righting this listing ship:

"The SNB cut its policy rate deep into negative territory. This will be something that will be watched with interest across central bank and financial market communities. Central banks have long feared cutting interest rates deep into negative territory for fear of unintended consequences. Banks may struggle to pass on negative rates to depositors, while at the same time finding it hard to not pass the rate cuts on to borrowers. Many also worry that deeply negative interest rates may incentivise individuals and companies to hoard cash outside of the banking system, raising a dual challenge of a hit to the banking system’s deposit base and net interest margins and a collapse in the velocity of money. Global central banks will be looking closely at the impact of negative interest rates on the Swiss banking and monetary system.

"Negative interest rates may also challenge a long-held investor belief that zero interest rates serve as a de facto lower bound to yields. As yields on short-dated bonds have fallen close to or even below zero in Japan and many countries in Europe, investors have sought protection in bonds with longer maturities or by moving their investments into other countries with higher interest rates. With policy rates deeply negative in Switzerland, yields on even longer maturity bonds have fallen close to or below zero. Market participants will look closely at developments in Swiss bond markets and interest rates as a possible roadmap of what might happen in other countries if more central banks were to go down the path of negative policy rates.

"Apart from the likely impact on economies and asset prices, this episode will also serve as an important lesson to investors on longevity and effectiveness of unconventional monetary policies. The sudden abandoning of an exchange rate regime that was supposed to be protected by the SNB (one of the G7 central banks that are at the centre of global monetary policy making) with “utmost determination” is a reminder to investors to be more cautious when it comes to risks surrounding an exit from unconventional monetary policies. A lot can go wrong, ranging from central bank communication, timing and sequencing of exit strategies and market reaction to any or all of them. SNB or foreign exchange policies are hardly alone in that respect. Arguably, what is now commonly known as “Taper Tantrum” was essentially the market’s reaction to the mere possibility of the U.S. Federal Reserve beginning to exit its unconventional monetary policy."

Continue reading at PIMCO Viewpoints

Image of Swiss F/A-18 Hornet target practice above Axalp in 2012 by Peter Gronemann