On Thursday, the Swiss central bank decided out of the blue to abandon the franc’s peg to the euro. The franc immediately soared in value while share prices plummeted.
Immediately after the announcement the franc rose 30%, eventually stabilising at almost 20% higher.
Ben Steinebach Head of Investment Strategy
The reason for the SCB’s decision was the high cost of maintaining the peg. At the height of the European debt crisis three years ago, as investors became more risk-averse and began to sell off shares, they fled en masse to safe havens. One of these was the Swiss franc, and the resulting upward pressure on the exchange rate was detrimental to the Swiss economy’s competitive strength. The Swiss central bank decided to peg the franc to the euro and intervened in the currency market to prevent the exchange rate from rising. This policy is now reaching its limits, yet abandoning it will, for the present, release the franc and cause it to appreciate significantly. Immediately after the announcement the franc rose 30%, eventually stabilising at almost 20% higher. This is of course bad news for Switzerland’s export industry and so also for tourism (especially with the snow season beginning), which is now suddenly 20% more expensive.
On the stock markets, this news has hit exporting companies such as Swatch, ABB, Richemond and Geberit hardest. The large multinationals such as Nestlé, Novartis, Roche and Adecco are much less affected, as they generally record their income and expense in dollars. Domestically oriented companies also remain largely untroubled by the more expensive franc. On balance, the Swiss stock exchange fell around 10% on Thursday; euro investors could still make a decent profit on the franc’s rise, though the weaker competitive position of some Swiss companies is still a factor to consider. Dutch residents with a second home in Switzerland might be affected depending on whether or not their home is still mortgaged. A net debt will result in a loss.
Another interesting development last week was the decision by the European Court of Justice on the legality of the programme by the European Central Bank (ECB) to buy government bonds in eurozone countries (that are in financial difficulties). This Outright Monetary Transaction programme, which the ECB introduced in 2012 in an effort to end the euro crisis, was met with criticism, particularly from Germany. However, the Court of Justice has now declared that the programme is legal. This appears to clear the way for the ECB to introduce a broader bond-buying programme. More news will hopefully follow this week.
DSM hit disproportionately hard by higher franc
Developments on the international stock markets presented different patterns – in regional terms – last week, with listings closing higher in Europe and closing lower in the United States. On the AEX, the appreciation of the Swiss franc put severe pressure on DSM. Part of the surge on the European markets can be attributed to a slightly greater drop on the US exchanges the Friday before, providing a lower baseline for the measurements. As the week progressed, however, on the whole the European markets also outperformed their American counterparts slightly. Apparently the US exchanges were still being held back slightly by the job report published the week before. Although the number of new jobs added in December (252,000) was higher than expected and unemployment continued to fall, the announcement at the same time that incomes had fallen by 0.2% (where they had been expected to rise by 0.2%) caused the sentiment to turn negative. This manifested itself in both lower prices on the stock markets and higher prices on the bond markets. The US 10-year yield even fell below 1.8% again.
Despite the upbeat sentiment on the European stock markets – which on average rose by 2.5% to 3.5% (with Germany’s DAX standing out at almost 4%) – European 10-year interest rates also fell, dropping below 0.5% in Germany and the Netherlands. The predictions about the ECB’s imminent announcement of a stimulus package were undoubtedly a factor in these developments, both on the stock markets and on the bond markets. With a gain of 2.3%, the AEX on average fell short of the other markets (with the obvious exception of the Swiss exchange). Among the listings on the index, oil companies – including Shell – initially fell as oil prices continued to drop, only to make a major recovery on Thursday when oil prices showed signs of stabilising (and even increasing slightly). DSM was hit very hard by the developments in Switzerland, where it produces vitamins, and its stock fell almost 9% on Thursday. However, we feel that the movements of the stock price are a somewhat exaggerated response. Although the company holds substantial interests in Switzerland, where it has invested EUR 800 million, half that amount has been hedged against the risk of foreign exchange differences. Moreover, DSM will in fact be able to profit more than most companies from the higher dollar (which will presumably continue to climb).
Further news expected from the ECB
With the Q4 2014 earnings season having begun with Alcoa reporting favourable results, the coming weeks will see a constant flow of information on this topic. However, in terms of macroeconomic news this will be a quiet week, although the ECB might as yet cause some excitement. US aluminium producer Alcoa, which traditionally kicks of the earnings season, recorded solid results during last year’s final quarter. It was followed by financial service providers JP Morgan and Wells Fargo; the former’s results were negatively affected by a penalty while the latter’s results corresponded more closely to the analysts’ forecasts.
This week’s news will include announcements of the earnings of IBM, Johnson & Johnson, Verizon, McDonald’s and General Electric. As a rule GE offers a fair indication of the state of the US economy as a whole. In Germany, SAP will be announcing its results and in the Netherlands we look forward to the results of ASML, Unilever and Sligro. In the macroeconomic arena retail data for November in Italy and the United Kingdom will be published. We also expect some details of leading indicators in both the United States and the eurozone and production prices in Germany. However, the focus will primarily be on the press conference that the ECB has scheduled for Thursday. It is doubtful, however, whether President Draghi will reveal his hand; he might prefer to wait for the outcome of the parliamentary elections in Greece that will be held on Sunday.