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 The Swiss National Bank's sudden decision to abandon its
three-year-old cap on the franc - the "cornerstone" of its monetary
policy just three days before - 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.
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 anaesthetise 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.
"Monetary methadone was the best of no choice but we have become
addicted to cheap money everywhere and, somehow, that central
bankers are prophetic," Nigel Wilson, chief executive of UK insurer
Legal & General told Reuters last week as he bemoaned the track
record of central banks over many years.
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.
The idea the world's largest economy was about to suck dollars back
out of the world just as others were pumping in euros and yen sent
once-steady exchange rates lurching. The power of the central banks
was as daunting as ever, but no longer such a reassuring and calming
influence.
THUNDERBOLT
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.
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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 euro zone and stave off euro
deflation? Will he even be there to see it through?
Stephen Jen, manager of the eponymous hedge fund SLJ Macro, reckons
the Swiss decision was as much about personalities as the durability
of the policy. The expansion of the central bank's balance sheet to
date did not leave it way out of whack by comparison with the likes
of Singapore, for example.
Jen argues the abandonment of the Swiss franc cap was simply a
personal preference of SNB chief Thomas Jordan who had inherited a
policy he never liked from predecessor Philipp Hildebrand.
"Perhaps the bigger point here is that central banking is
increasingly being driven by the personalities rather than the
institutions," Jen said.
Would the Bank of Japan have adopted its last two waves of so-called
"quantitative and qualitative easing" without governor Haruhiko
Kuroda in charge? Would the Fed have launched three rounds of QE
without Ben Bernanke at the helm?
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."
(Graphics by Vincent Flasseur and Divyang Shah; Editing by Peter
Graff)
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