Swiss Franc’s Surge = Chaos In Global Currency Markets by Gary D. Halbert
FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
January 20, 2015
IN THIS ISSUE:
- US Economy Stumbled Based on 4Q Reports
- Swiss Franc’s Surge Led to Turmoil in Global Forex Markets
- Switzerland Abandons Its Currency “Peg” to the Euro
- How a Stronger Swiss Franc Will Hurt Its Economy
- The ECB to Announce QE Bond Buying This Week
Last Thursday, the Swiss National Bank stunned the financial world by decoupling the Swiss franc from the euro. This surprise move sent the franc up almost 40% against the euro in one day, although it didn’t close that high (up 19%). Nevertheless, many currency traders, banks and brokerages were left with devastating losses. I’ll give you the details below.
But first, let’s take a look at the recent US economic data which has been disappointing overall. Following the stronger than expected GDP growth of 5% (annual rate) in the 3Q, the US economy seemed to stumble a bit in the 4Q. We’ll cover the latest reports before shifting our attention to Europe and Switzerland in particular.
US Economy Stumbled Based on 4Q Reports
A year in which the US economy was supposed to turn the corner and lead the world ended in a bumpy fashion. Retail sales, manufacturing and inflation readings sputtered in late 2014, according to reports released this month. Meanwhile, weekly jobless claims jumped back above 300,000 and a new study called a rebirth of US manufacturing a “myth.”
Economists generally remain hopeful that the new year will turn out well, despite the slowness suggested by the latest reports. Most forecasters still believe that sharply lower energy prices will boost consumer spending this year and breathe life into an economy that grew at about a 2.4% annualized clip in 2014. GDP is expected to climb above 3% for 2015.
However, the early indications are that consumers pocketed the savings they got from plunging prices at the pump. Retail sales for December saw a stunning 0.9% decline, missing even the most modest estimates for the holiday shopping season.
That disappointment was enough for Goldman Sachs to slice its 2015 projection for GDP from 3.1% to 2.8% last week, noting that consumer spending “appears at least somewhat less favorable than we were expecting” but noted that fundamentals are still strong due to steady job creation, lower gas prices and rising consumer confidence.
Indeed, the widely followed University of Michigan Consumer Sentiment Index hit an 11-year high in January, which led some forecasters to conclude that the surprise drop in retail sales in December was likely a fluke. We’ll see.
In the bigger picture, rising consumer sentiment is all well and good – and who wouldn’t be happy with gas prices below $2 a gallon? Yet the full economic impact remains to be seen. Saving money at the pump is one thing, but if it doesn’t translate into a more active consumer spending elsewhere, then the net effect is lessened.
As for the manufacturing sector, a new report from the Information Technology and Innovation Foundation, a Washington-based think tank, asserts that the sector’s growth has been merely tepid since the Great Recession ended in 2009. “American manufacturing has still not recovered to 2007 output or employment levels,” the study says. An article on this topic appears in the links at the end of today’s E-Letter.
On another front, interest rates continue to fall more than just about anyone expected. The 10-year Treasury yield has plunged over the last couple of months, falling below 1.8% today, down from 2.25% last month. Meanwhile, the yield on 30-year Treasury bonds has plunged below 2.5%, down from above 3% just a couple of months ago. Most forecasters expected rates to rise in 2015 but are now adjusting their projections lower, while many are rethinking whether or not the Fed will raise short-term rates this year.
A few other things to consider: Years of global central bank easing that has seen more than $5 trillion in liquidity injected into capital markets resulted in surging asset prices, particularly stocks. Yet even that hasn’t cured disinflationary pressures, most recently manifested in the biggest drop the consumer price index has seen in six years (-0.4% in December), as plunging energy costs more than offset a 3.4% annualized gain in food prices.
Elsewhere, that 252,000 job creation number from last Friday’s nonfarm payrolls report came with a decline in actual hourly earnings and a 36-year low in the labor force participation rate. While the official unemployment rate unexpectedly shrank to 5.6% from 5.8% in November, the decline was largely due to the shrinking labor force.
Those are the highlights of the latest economic data. Now let’s turn our sights to Europe and specifically the latest shocker from Switzerland, that bastion of fine watches, cuckoo clocks and sound money – at least until last week.
Swiss Franc’s Surge Led to Turmoil in Global Forex Markets
In a complete surprise decision last Thursday, the Swiss National Bank (equivalent of our Federal Reserve) shocked the global financial markets by announcing that it is abandoning its policy of limiting how much the franc can rise against the euro, and therefore the US dollar.
Immediately after the announcement, the Swiss franc exploded higher by almost 40% against the euro on Thursday, which resulted in massive losses at many forex dealers and brokerages that had been “short” the franc due to the currency “cap” or “peg” that was abandoned. Numerous bankruptcies of such firms are expected to be announced in the days just ahead.
Most Americans heard little or nothing about this surprise decision by the Swiss National Bank or the currency market chaos that followed. Yet American investors should know about this because it means worsening deflation in Europe, a further decline in the euro and an increased chance that deflation will visit our own shores.
Deflation is a very troubling economic development and one that is very hard to reverse. Think Japan over the last two decades – they are still in a deflationary spiral. We do not want to go there. Neither did Switzerland, but that is where the country is almost certainly headed.
I’ll do my best to explain what it all means below. I will also discuss why it is widely expected that the European Central Bank will announce a huge new “Quantitative Easing” program this Thursday in an effort to stimulate the sagging economies in the region. Never mind that QE arguably didn’t work here and it’s not likely to work there either.
Switzerland Abandons Its Currency “Peg” to the Euro
Switzerland has traditionally been considered a “safe haven” country to park your money. Its banking system has long been considered one of the strongest and safest on the planet. And the Swiss franc has long been one of the most trusted currencies. But as of last Thursday, all of that has come into question.
Let me go back and explain how the latest developments occurred. When most of us think of Switzerland, we think of fine watches, cuckoo clocks, financial privacy and sound money policies. With the Swiss, you don’t get surprises… Until you do.
Last Thursday, the Swiss National Bank (SNB) shocked the financial world with a double whammy – simultaneously abandoning