SNB capitulates and abandons the floor - initial thoughts
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The SNB’s decision to abandon the floor for EUR/CHF is remarkable but not unwarranted. As we have long argued and indeed positioned for, the SNB was losing the ability to prevent an increasingly justified depreciation in the euro against the franc. The pressure was bought to a head by the prospects for ECB QE and the SNB’s inability to substantially expand its balance sheet from an already bloated 85% of GDP.
The timing of the move may have had part to do with the release last week of the SNB’s massive profits for 2014 (CHF 38bn) which provide a sizeable cushion against the mark-to-market losses the SNB will suffer on its reserve portfolio (the SNB would have been bankrupted by this de-pegging had it not made such a large profit last year).
Most surprising in today’s decision is that the SNB has not chosen to retreats in a managed fashion – it has completely removed the floor such that EUR/CHF is now free floating. This is the cleanest option for the SNB – all ties to ECB policy can now be cut - but also the one with the greatest risk of triggering an undershoot in EUR/CHF from fair-value (which we put around 1.10) as it forces an accelerated unwind of non-resident franc funding (probably in the region of CHF 150-175bn). The SNB is attempting to manage the risk of an undershoot by further lowering interest rates by 50bp (the sight deposit rate is now -75bp), but this is almost inconsequential in the context of the kind of flows and balance sheet stress for many private sector participants that today’s decision will unleash.
We are currently short EUR/CHF through a 1.2088 put, expiry 16 March. This is currently valued around 40%. We will hold for now but look to unwind if spot dips much below 0.90.
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