Why The Swiss Franc Matters, And Doesn’t

Why does anyone care about the Swiss franc? It’s a legitimate question, and one I was asked at least 10 times yesterday. 

While it’s unlikely that the U.S. dollar is headed for anything like this strong a surprise, the action in the Swiss franc yesterday is a primer on how currencies affect investors. 

A country smaller in population than New York City, an economy smaller than Belgium or Vietnam, Switzerland on the surface shouldn’t actually matter all that much on the global stage except as a tourist destination.

But it does.

Why Switzerland Matters

The reason is mostly political. By remaining fiercely independent since the 1800s, and also rich—it’s the wealthiest country in the world per capita—Switzerland has become a safe haven for capitalists of all sorts. While the storied Swiss bank accounts of international thrillers aren’t quite the black holes they used to be, there is still an enormous amount of money tied up in Switzerland. 

The Swiss franc itself was seen, at least until recently, as a zero-inflation safe-haven currency. Until 2000, it was legally backed 40 percent by Swiss gold reserves. Since then, it’s joined the ranks of fiat currencies, and has been more volatile.

So what’s the problem? Well, as a safe-haven currency, it came under enormous pressure as the euro has faced issues in the past five years. As in upward pressure. The franc soared as the euro crashed, and Greece went down the toilet, running from 1.67 euro per Swiss franc down to 1.13 euro to the franc in 2011. The dollar came along for the ride, somewhat mutedly.

Why does this matter?

Well, if you’re a Swiss manufacturer, your goods have become enormously expensive to all of the buyers outside your own borders. At its peak, The Economist declared the franc 98 percent overvalued versus the dollar, and Swiss companies started threatening to move their operations out of the country.

The Swiss Currency Peg

The Swiss National Bank intervened, saying it would directly intervene in the currency markets to keep the franc from becoming any stronger than 1.20 euro. In other words, every time it saw the euro head below 1.20, the Swiss central bank would go into the market, print francs and use them to buy up euros. That made the euro stronger while diluting the value of the Swiss franc.

It worked, in a way. The Swiss bank successfully kept the franc devalued. Until yesterday that is, when it simply stopped. 

What Now?

When the SNB started all this, many economists wrote things along the lines of, “This will work, but they day it stops, the balance sheet of Switzerland will look terrible.” And in fact, that’s exactly what’s happened. 

The SNB is currently sitting on 174 billion euros, slightly less than half of all its foreign currency reserves. Put another way, the balance sheet of the SNB as of its last report was a total of 524 billion Swiss francs, of which 210 billion Swiss francs was held in euros. That huge slug of assets just lost about 17 percent, with the euro now trading at par for the franc.

As a U.S. investor, there are a few things to note:

1. You are only directly affected if you are long the franc. Investors in the CurrencyShares Swiss Franc Trust (FXF | A-99)—the only game in town for Swiss franc ETFs—had a very, very good day, bagging a 17 percent gain in a single day.
2. If you owned Swiss stocks in unhedged ETF like the iShares MSCI Switzerland Capped ETF (EWL | B-96), you in fact also had a good day. While the local shares of companies like Nestle SA are down more than 10 percent in local terms, U.S. investors got to book the currency move as well, so EWL actually closed up almost 4 percent yesterday. From here on out, however, Swiss companies face a new head wind, and I’d be very skeptical of a direct investment.
3. If you were holding a hedged product, like the Deutsche X-Trackers MSCI Europe Hedged Equity ETF (DBEF | B-66), you took the hit on the Swiss holdings (sorry Matt Hougan), and missed out on the rally in the franc; that is, after all, the point of hedging out the currency exposure. DBEF ended up down just shy of 1 percent yesterday.

Time For Pause

Going forward, the important question for investors is whether they should be re-evaluating their hedged Europe exposure, if they had any.

Because the Swiss franc had been pegged to the euro, the case for hedging against a weak euro/strong dollar combo was pretty clear. 

But with Switzerland now floating, funds like DBEF are now only about half exposed to the euro, with the remainder of the stocks in pounds or Swiss francs. The case against those two currencies is significantly less clear. 

And what about U.S. investors who had only broad international holdings? 

At the risk of sounding Pollyanna, I never see direct currency battles as ultimately a good thing for the global capital markets. They by definition distort reality. Level playing fields, in the long run, build more global wealth.

So while yesterday was a very bad day to be the chief financial officer of a Swiss exporter, I think most of us can just sit back and watch without too much concern.

At the time this article was written, the author held no positions in the securities mentioned. You can reach Dave Nadig at [email protected], or on Twitter @DaveNadig.