Over the past few years there has been a remarkable convergence in the performance of the Swiss Franc and the Japanese Yen. A lot of this has been due to the effects of traders reversing “Carry Trades” in each country as this feature of world economic life was carried out on an enormous scale. In addition both currencies have seen themselves regarded as “safe havens” in the credit crunch era. However recently this link has been broken and there are considerable consequences from this.
The Carry Trade
For those who have not followed my updates on this then it involved the following and you need to remind yourself that there was a time before the current era when interest-rates were low in only a few countries and in particular they were low in Switzerland and Japan. Investors decided to borrow at these low interest-rates and invest the money in places with higher interest-rates. One example of this was where money was borrowed in Swiss Francs to finance mortgages in Eastern Europe (Poland and Hungary mostly). If we ignore the danger for the mortgage borrower and just look at the Swiss Franc we see that it will see its value being depressed as the trade is analogous to selling it. So we saw a sustained period in the middle of the last decade when the Yen and Swiss France were forced lower.
However as interest-rates fell elsewhere and the credit crunch era made the Yen and Swiss Franc look like safe haven currencies the carry trade began to reverse. You may now see the problem as already strengthening currencies got another push higher. The Swiss Franc rose from buying 0.8 US dollar’s in the summer of 2007 to buying 1.41 in August of last year. Over the same time period if cost 123 Yen to buy a US dollar and then just under 76.
Recently they have diverged
Over the past couple of weeks we have seen something of a divergence between the Yen and the Swiss Franc. You see the Yen has weakened but the Swiss Franc has not and there has been quite frantic trading in the Yen overnight as it pushed lower to 81.60 versus the US dollar compared to 76 at the beginning of the month. Trading here is volatile and the Yen has strengthened again to 81 so the exact picture is unclear but it has posed the question are we seeing a reversal in the Yen? If so there are plenty of economic consequences.
Currency Flight from the Euro zone?
Bloomberg News calculates figures for total deposits in banking systems and we can see from them that money is leaving certain Euro banking systems. In Greece some 28% of deposits have left since the summer of 2009 for example. However the problem has spread as Spain has seen its bank deposits fall from 979.5 billion Euros last summer to 942.3 billion at the end of December (and this probably flatters the situation as deposits tend to rise in December). Also Italy had shown some signs of this before the year end effect wiped it out.
So where has the money gone? Some will have gone into the German banking system for a higher level of perceived security but take a look at the exchange rates for a clue too.
The Euro has been strong recently
Unfortunately the mainstream media only really cover falls in the Euro but since the middle of January when it dropped to 1.26 versus the US dollar it has been strong and is now over 1.34 as I type this. If we look at it versus the Japanese yen we see that it has put in a strongman type performance. On the 16th of January one Euro purchased only 97.25 Yen whereas as I type this it will purchase some 108.3 having nearly touched 110 this morning. Just as an aside if we were discussing most other currencies we would have been talking about a Yen rout and it is important to recall that this is reversing a period of considerable strength, but for the first time in many moons we can wonder if we are seeing a reversal of a trend. If you wish to consider this by time then the Yen has gone back to where it was in late October 2011.
The Swiss Franc
Here we see quite a different performance and for a musical accompaniment we can play this by Ashford and Simpson.
Solid as a rock
And nothing’s changed it
Actually that understates the performance of the Swissy as if we look back to mid-January when the Euro began to strengthen it was at 1.21 and it is at 1.2048 now. Indeed after the Swiss National Bank established a cap at 1.20 late last summer it had been pushed down to 1.24 but since early December it has kept edging forwards. If it keeps this up it may not be too long before we find out what the Swiss National Bank meant by “unlimited intervention” and the SNB may well end up ruing its hyperbole and bombast.
If we look at the exchange rate pattern it is hard to avoid the conclusion that money has been leaving the Euro for the perceived refuge of the Swiss Franc. Also it may be on a larger scale than we might think as currency traders are likely to sell the Swissy ahead of the 1.20 cap thinking that if it goes wrong the SNB will provide a relatively cheap stop loss. Yet again central bank action makes perception and reality diverge, no wonder people get confused!
We find ourselves looking at another unstable situation which could move very fast. It has quite a few implications. For example if we look at one measure for Switzerland her monetary base measure of money supply was below 50 billion Swiss Francs in 2008 before she began intervening to weaken the Swiss Franc and is now 227 billion. Even her widest measure os money supply called M3 has expanded from 626 billion Swiss Francs in 2008 to 788.8 billion in January 2012. Most central banks would regard that as something of a nirvana and the equivalent of scoring a century before lunch at Lords! Sadly the credit crunch era mostly gives to those who do not want to receive and there is little point in Mervyn King taking a flight to Geneva and trying to understand the concept of a strong currency….
Consequences for Eastern Europe
Here we see that unpleasant phrase “collateral damage” as Swiss Franc, and indeed Euro strength, punishes foreign currency mortgage holders one more time. The situation remains grim here and added to it we have another problem from the Euro crisis. Take a look at this from Bulgaria (h/t bdefore).
Bank-related capital outflows from emerging Europe were “substantial” in the second part of last year, the EBRD said.
The EBRD is the European Bank for Reconstruction and Development and if we look into the problem we see this is we focus on Bulgaria.
Greekbanks hold nearly a 30% of the Bulgarianbanking market, a 20% share of the bank loans and one-third of all deposits.
Just what you don’t need is a banking sector populated by zombie banks! There are some other familiar players such as Italy’s Unicredit but at least for UK readers there is no sign of Royal Bank of Scotland which usually features in such lists.
Looking at the pattern of exchange rate movements we see that the Swiss Franc is back at least for now and it seems clear that this likely to be because of currency flight from the Euro. Frankly would you buy the Swiss Franc at this level otherwise? Yet again we find ourselves in an unstable situation and we return I think to my view of Euro zone operations which sometimes bring tactical success but invariably bring strategic failure. the latest liquidity provisions of which we will see more this week is likely to illustrate the Lucas Critique one more time I think. In its own area it may well look a success but problems will leak out elsewhere and the Swiss Franc and Eastern Europe are likely to be warning signs.
The Yen what next?
I cannot help but wonder if finally we may have seen a turn in it. In many ways its surge has gone against logic but resisting it has ended up being an example of the City phrase “trying to catch a falling knife”. Care is needed as the Bank of Japan has been indulging in stealth intervention and accordingly we may be seeing another case of central bank meddling in matters it might be best to leave alone. I do wonder if it led today’s fall to 81.61 versus the US dollar, although if it did the current level of 80.40 has been a very fast reversal.
The American investor Kyle Bass who has put his mortgage in Japanese Yen will no doubt be on tenterhooks right now. As a final thought can the world afford another weak currency, after all not every currency can fall……….