World Economy

What if Central Banks Follow SNB Move?

What if Central Banks Follow SNB Move?What if Central Banks Follow SNB Move?

The Swiss currency shock has raised an awkward question many investors have been fearful of asking – what if central banks become as unpredictable and fallible as they are powerful?

The Swiss National Bank's sudden decision to abandon its three-year-old cap on the franc – the "cornerstone" of its monetary policy just last week – led to the biggest one-day move in major exchange rates in the post-1973 floating rates era. To some it was a warning sign of other U-turns, mishaps and possible failures by central banks still ahead, outcomes not fully appreciated by long-becalmed markets, Reuters reported.

For decades the power of currency printing presses has held markets in thrall. "Don't fight the Fed" and all its international variations has been a devout belief among financial traders.

Even after the failure of Alan Greenspan's Federal Reserve to spot and headoff one of the biggest credit booms and busts in history, the ability of the Fed, Bank of England, Bank of Japan, European Central Bank and others to flood their money supply to ease the fallout helped anaesthetize fractious markets.

The subsequent waves of cheap credit, currency fixes and "quantitative easing" drove down borrowing rates and erased volatility.

The demonstrations of central bank might culminated in ECB chief Mario Draghi's declaration in 2012 that he would do "whatever it takes" to save the euro. In the face of the power of the money printing press, speculation became pointless.

So much so that one of the biggest conundrums of recent years became the persistently low implied volatility in markets even in the face of outsized economic, political and policy risks. Not everyone was pleased by the complacency.

The first cracks appeared last summer, when it became clear the Fed was turning off the printing presses even as counterparts in Europe and Japan were still cranking up theirs.


Last week's thunderbolt from the Swiss authorities went further by calling into question whether central banks are as committed to their policies as they purport to be.

The SNB may simply have tried to pre-empt a flood of euro sales expected after the ECB announces sovereign QE this week. But in allowing 30 percent plus franc appreciation it delivered its ailing economy a harsh blow, which few outsiders saw as unavoidable.

And for a major central bank to twice proclaim the virtue of effectively printing Swiss francs at a fixed 1.20 per euro, only to scrap the cap within the week, injects an element of randomness into monetary policymaking not seen for many years.

Can investors now be sure now Denmark's central bank – facing a similar problem of holding a long-standing crown peg to a weakening euro – will hold the line as it repeatedly promises?

Or more immediately, will Draghi stay good to his commitment to do "whatever it takes" to sustain the eurozone and stave off euro deflation? Will he even be there to see it through?

Perhaps a bigger question in a week when the ECB is expected to break considerable political ice by announcing sovereign bond buying for the first time is how central Draghi is personally to the "whatever it takes" phrase he himself made so powerful?

Whatever it takes for Draghi might not be whatever it takes for his successor.

Financial markets, whose bond pricing already doubts the ECB can hit its 2 percent inflation target over the next 10 years, are already starting to pay the price of central bank wavering and lack of cooperation with higher volatility.

"The ECB has a huge task this week to restore confidence and trust in financial markets," said Jaisal Pastakia, investment manager at Heartwood Investment Management. "The ECB’s record has been commendable ... but the stakes are getting higher."