The Swiss National Bank's removal of the franc's peg to the euro last week had far-reaching consequences because we were all taken by surprise. The fact that it would (and should) happen eventually was not lost on the market, but the SNB was as late as last week end talking tough and telling the market that the floor was an integral part of Swiss monetary policy – until it suddenly wasn't any more.
I fully understand the rationale for the move () but like most of the market I'm extremely disappointed in the SNB’s communication and handling of the issue, but that’s the bigger lesson: Why is it most people trust or bother to listen to central banks?
Major central banks claim to be independent, but they are totally under the control of politicians. Many developed countries have tried to anchor an independent central bank to offset pressure from politicians and that’s all well and good in principle until the economy spins out of control – at zero-bound growth and rates central banks and politicians becomes one in a survival mode where rules are broken and bent to fit an agenda of buying more time.
Just looks to the Eurozone crisis over the past eight years – if not in the letter of law, then in spirit, every single criterion of the EU treaty has been violated by the need to “keep the show on the road”. No, the conclusion has to that there are no independent central banks anywhere! There are some who pretend to be, but not a single one operates in true independence.
That’s the reality of the moment. I would not be surprised to find that the Swiss Government overruled the SNB last week and the interesting question for this week is of course if the German government will overrule the Bundesbank on quantitative easing to save face for the Eurozone? Probably….
The new dimension of central banking is the “communications policy” which is not only the poorest policy but also only really a front for “talking the market into believing our dream” without any further action.
Look at the Federal Reserve forward-looking guidance: They are constantly over-optimistic on growth and inflation. Constantly. The joke doing the rounds is that to get the proper GDP and inflation forecast you merely take the Fed's own forecasts and deduct 100-150 bps from both growth and inflation targets and voila! You have best track record over time.
Studies shows that the business cycle was less volatile before the Federal Reserves was born. The birth of the Fed meant leverage (gearing) which of course has resulted in bigger and bigger collapses of the economy, but with a trend of major crashes increasing in frequency: 1987 stock crash, 1992 ERM crisis, 1993 Mexico “Tequila crisis”, 1998 Asian crisis and the Russian default, 2000 NASDAQ bubble, 2008 stock market crash, and now 2015 SNB, ECB QE, Russia and China and what's the next crisis?
I don’t know, but clearly the world of finance and the flow of money is increasing its velocity meaning considerably more “volatility”. By the way, the only guarantee I issued at the end of 2014 looking into 2015 was:
Where does this all bring me? The SNB's action was really the culmination of bigger and bigger moves at the end of a low volatility paradigm. I have been trading currencies for more than 30 years, Thursday’s move was single biggest move I have experienced in one market. But let’s look at other remarkable moves this year:
Oil has dropped more than 50%
Russian ruble falls off a USD cliff
EURNOK had it biggest move in many, many years (15% in space of a few days)
EURCHF move in comparison:
Even overnight, the Shanghai index dropped more than 7%
– the biggest move in years on margin calls:
The lesson is clearly that the market has been trying to tell us for a long time that volatility was a function of an economic model of suspending the business cycle. When you suspend an economic system such as the world markets for an extended period you ultimately release more energy when the business cycle starts anew.
We started the year with Maximum Dislocation of the market in a model of planned economies. We have bond and credit spreads at historic lows, currencies at extremes, equities and real estate in bubble-like valuations, and a geopolitical risk which keeps rising as seen this year in Paris, last year in Ukraine and also the rise of ISIS.
The US dollar is putting pressure not only on US itself but also the world. A journalist asked me last week: Who benefits from a stronger US dollar? I still owe him an answer because very few benefit. In fact the world has two growth engines: The US and emerging markets. Both are pretty much US dollar economies. Debt (US dollar funding) in EM has exploded to an extent that many including the World Bank now call a for risk of “Perfect Storm in EM”. Both US and EM became credit junkies over the QE-to-infinity era in the US. The law of unintended consequences.
Another unintended consequence was that energy was the trigger for the crisis in 2008 as rising energy prices took five trillion US dollars out of the economy – which became the catalyst for the Eurozone crisis and US banking bailout. Now eight year later the drop in energy has broad spillover effects as the wealth is transferred from sovereign wealth funds in resource countries to consumers.
That’s good for Main Street and bad for Wall Street as the “bid” in the assets disappear as these sovereign buyers needs to draw down on their wealth instead of buying overseas assets. Similarly, will a direct impact from SNB not having a floor be less NASDAQ buying which famously SNB had in its portfolio?
Meanwhile the fact that volatility is rising, the fact that we see early signs of the business cycle being activated, is good for the real economy. It’s a sign of money flowing from the 20% QE induced overvalued listed companies to the 80% SMEs (the real economy) as increase in volatility will make expected return less in “paper money” and more attractive in tangible assets and good business.
The world should be concerned when volatility is too low, it’s a sign of the market not allocating money correctly. The one lesson everyone needs to learn is that for a market based economy to function you need to allocate capital to the highest marginal real return of capital. Not to the most politically connected.
When history of 2015 is written I have no doubt that the Paris terror act and SNB's removal of the floor will stand out – both happened less than two weeks into 2015, although that is random, what is not random is that market volatility has been rising directly and indirectly through a misallocation of capital directed by the central bank system.
Many central banks will envy the SNB for its move last week, as it at least tries to regain some control of its future, but the conclusion remains: central banks have as a group lost credibility and when the ECB starts QE this week the beginning of the end for central banks is completed. They are running out of time – that’s the real real bottom line: the SNB ran out of time, the ECB will runout of time this week, and the Fed, Bank of Japan and the Bank of England ran out of time in 2014.
What comes now is a new reality – the SNB move was a true paradigm shift – we can no longer look at central banks, the markets and extend-and-pretend in the same light as we did last Wednesday (the day before the SNB pounced).
The king is dead, long live the King.