January 2015 Monthly Commentary
The ad hoc monetary policy of the Global Central Banks and their “beggar thy neighbor” currency policies turned downright bizarre in January resulting in a sharp and unexpected rally in bond prices.
On the morning of January 14th, the Swiss National Bank (SNB) shocked the capital markets by abandoning its exchange peg against the Euro currency. Since 2011, the SNB has consistently intervened in the currency market, selling the Swiss Franc against the Euro to prevent their currency from appreciating versus that of their neighbors. On a comparative basis, Switzerland is considered a bastion of stability amid the single currency mess in which Europe finds itself. However, demand for the Swiss Franc had become so great that the SNB could no longer afford to support the peg, which involves selling the Franc and buying Euro’s. Essentially, their Euro position had grown too large. In the moments after the move was announced, the Franc appreciated by nearly 30% versus the Euro before closing the day 14% higher. The rate movement against the U.S. Dollar was similar, as one would expect.
One week later, Central bank policy shocked the markets again when the European Central Bank, the Bank of Canada, and the Banco Central do Brazil all intervened. The economies of Brazil and Canada, both highly dependent on commodity exporting, have suffered with the plunge in the price of crude oil. As a result, the currencies of both nations have plunged versus their major trading partners. The Loonie, as the Canadian dollar is known, has fallen sharply in value versus the U.S. dollar, dragged down with the fall in commodities prices. In response, the BOC cut interest rates from 1% to 0.75% in a move that surprised investors and caused the currency to plunge nearly 7% versus the dollar for the month. The Brazilian Central Bank, while suffering a similar downward trajectory in the value of the Real, also due to a falloff in commodity exports, took the opposite tack and raised the overnight lending rate from 11.75% to 12.25%. The Brazilians have always been manipulators of their currency, concerned that a falling currency would raise the cost of servicing their non-Real denominated debt, while also worried that an expensive currency would have a detrimental impact on growth.
On the same day, the European Central Bank leaked news that the Quantitative Easing (Money Printing) exercise they were expected to announce on the following day would amount to 50 Billion Euros a month. Investors were cheered by the rumor as it had been anticipated that the monthly purchases would be approximately 30 billion Euros. However, at the post-meeting press conference, Chairman Draghi further surprised investors by communicating that the rate of monthly purchases would actually be 60 billion and would run at least until October 2016, but could be extended beyond that date if required. In essence the ECB is flooding the markets with newly minted Euros in an effort to achieve sustainable economic growth. In doing so, the Europeans join the Bank of Japan and the Federal Reserve in the practice of printing money and using it to buy government debt. We’ve been critical of the practice and have written about it on numerous occasions, and are no less so in the case of Europe. Arguably, the challenges facing the European economies are much different than those that the U.S. faced. The level of indebtedness, social programs, and work ethic, vary across member countries posing a structural challenge to the continent’s economic advance. Moreover, consumption is constrained by the high level of value-added taxes. With interest rates already at very low levels, and in some cases negative levels, the ECB hopes that the program will encourage banks to make loans with the newly printed Euros and hopefully a virtuous circle of business and job growth would ensue, much as has occurred in the U.S. However, the big question is what will the unintended consequences will be?