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Foreign Exchange

Capital controls anyone? Markets take on Swiss National Bank and test EURCHF floor

EURCHF dropped through the Swiss National Bank’s (SNB) SFr1.20 floor on Thursday for the first time since the central bank imposed the peg in September.

The move followed a steady grind lower in EURCHF amid increasing talk that funds were preparing to test the SNB’s credibility and push the franc higher.  The exact trigger for the move is up for debate.

One can choose from: figures earlier in the day, which showed that the SNB’s currency reserves rose from SFr227.2 billion in February to SFr237.5 billion in March – implying the central bank has had to be more active in the market defending the floor; stronger-than-expected Swiss CPI data; or a renewed rise in tensions in the eurozone, which saw fresh rises in peripheral eurozone bond yields.

The probable trigger is more prosaic: that stop losses were taken out beneath SFr1.2030 and the market wanted to take on the SNB in holiday-thinned trade and test whether anyone was still manning the desks in Zurich so close to the Easter holidays.

Whatever the reason, the reaction from Zurich was immediate. Dealers report about close €10 billion of bids at SFr1.20, (about €1.5 billion to €2 billion of which got filled), while an SNB spokesman was quickly on the wires saying that the SNB will not accept a EURCHF rate below SFr1.20 and is committed to buying FX unlimited quantities to defend the floor.

EURCHF, which shot down to a low of SFr1.1998 in seconds after the SFr1.2030 level broke, promptly rebounded to around SFr1.2010.

However, there is plenty of danger lurking below the figure. Citi last month estimated there are stop losses of between €7 and €10 billion lurking under the figure and that, should the SFr1.20 floor break decisively, EURCHF would move to at least a SFr1.18 handle in fairly short order.

Morgan Stanley, meanwhile, has warned a break of SFr1.20 would trigger option hedging that could push EURCHF back down to the record low of SFr1.0094 it hit last August.

For now, the perceived wisdom appears to be that the floor will hold.

After all, the SNB is trying to put a lid on currency strength. It controls the printing press and, unlike the Bank of England, which was trying to defend the value of its currency before it was defenestrated from the European Exchange Rate Mechanism in 1992, is in a position of strength.

That rather misses the point, however. Intervention means the SNB will keep accumulating a currency – in this case the euro – over which it has no control and thus leaves it exposed to a flare up in tensions in the euro and even, in the extreme, a break-up of the single currency.

So what options does the SNB have?

It could use the weakness in EURCHF to accumulate more euros and then raise the floor to, say, SFr1.25. But, as Kit Juckes, head of G10 FX strategy at Société Générale, says, that seems unlikely behaviour for sober central bankers.

A more radical solution could erase the problem of fighting the markets. The SNB could go the whole hog and introduce capital controls.

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