Legg Mason: SNB’s move in currency markets could be first of many

Legg Mason subsidiary Brandywine analyses the shock move by the Swiss National Bank to scrap the Swiss franc’s peg to the euro.
The Swiss National Bank’s decision to scrap the 1.20 EUR/CHF level and cut rates to -0.75% was unexpected and caught the market off guard yesterday. While we are still digesting the implications, there are a few things that are apparent to us following the news.
The Swiss National Bank put the ceiling in place in 2011 due to the overvaluation of the franc. Monetary conditions have changed since then, and the euro and franc have weakened. Another key factor is the upcoming ECB announcement. In the increasingly likely event that the ECB announces QE next week, and the Euro weakens as a result of it, the Swiss National Bank would be required to intervene further in order to maintain the 1.20 level – a move that would have pressured the Swiss National Bank to increase its exposure to the Euro and further expand its balance sheet.
Switzerland, like the rest of Europe, is experiencing deflation that will only worsen with the recent CHF appreciation. This leaves the Swiss National Bank in a tough situation that could result in them pursuing other avenues to counter appreciation in the CHF. This could include buying USD/CHF or targeting CHF levels versus a basket of other currencies.
Importantly, in yesterday’s press release the Swiss National Bank noted “If necessary, it will therefore remain active in the foreign exchange market to influence monetary conditions”. We believe that the news also sends the message that the ECB is likely to engage in QE.
The Legg Mason Brandywine Global Income Optimiser Fund maintains a 6% short in the EUR, which we are comfortable with at this point.