The Swiss Franc

Preventing the Swiss Franc from growing too strong.

Last week on 6 September the markets were surprised by the Swiss National Bank's (SNB) intervention into the Swiss franc which aimed to stop the currency's steadily increasing price. But why did they do this and why should investors care?

The SNB took the action to weaken the CHF to protect the economy, particularly the export market which can be severely harmed if the currency becomes too strong.

Another significant indicator of a country's economic growth is Gross Domestic Product (GDP). These announcements are highly watched by investors because they provide insight into the total market value of goods and services produced in a country over a given time period.

Last week Australia's GDP revealed 1.2% growth quarter on quarter and 1.4% growth year on year. This strong result immediately increased the value of the Australian dollar (AUD) providing a great opportunity for speculative traders to profit.

All countries want to export their goods to establish favourable growth and some countries rely on exports more than others. Take Japan for example. The third largest economy in the world is a major exporter of automobiles, consumer electronics, computers and many more popular goods. In recent years exports have made up approximately 16% of Japan's total GDP, hence a strong yen is unfavourable because it has the potential to harm the economy by deterring overseas buyers with increased export prices.

What can a central bank do when global events are driving its currency to undesirable high levels? One solution is to intervene like the SNB have done. This is the practice of a central bank buying and selling one or more currencies to affect the exchange rate of its own currency.

Last week's action by the SNB stimulated a massive shift in the euro to Swiss franc (EUR/CHF), pulling the pair up over 10% in the space of three hours. This was considered the biggest currency move in recent history.

To put some perspective on this, if you had bought EUR 10,000 against the CHF (which you can do with a GBP 50 margin) before the announcement, the move of 10% on a deal of this size would have generated a profit of around GBP 800 profit. That is a truly remarkable return.

The SNB holds its quarterly policy review this Thursday. After the recent policy move, that included lowering the 3-month LIBOR target to 0-25 bp from 0-75 bp, new fresh initiative is likely to be forthcoming. However, there has been some speculation that the SNB may chose to manage its new foreign currency holdings differently, such as the creation of a sovereign wealth fund, or chose not to mark-to-market part of its reserves.

Gold is still considered as a safer investment and its price cannot be directly controlled by one country's central bank actions. UBS has reported that gold could reach USD 2,000 this year. And at times when risk looms and investors look to stash their cash in a safe place we may see other currencies, such as the Swedish krona (SEK) and Norwegian krone (NOK), strengthen against the euro.