Swiss central bank buys euros to fight deflation, dollar rises

The Swiss National Bank (SNB) has aggressively intervened in the currency market to weaken the Swiss franc and strengthen the euro, an action that's solidified bullish sentiment in equity markets, boosting the dollar.

The SNB cut its main lending rate to 0.25% from 0.50%, and, equally significant, it said it would buy currencies to end the rise of the Swiss franc, Bloomberg News reported Thursday.

The dollar and euro both rocketed higher Thursday against the Swiss franc on the SNB decision: the dollar rose more than 3 cents to $1.1907 and the euro surged more than 4 cents to $1.5305. To give investors perspective on the size of the move: a one-half cent move is considered a substantial change in the currency market. Today's dollar-franc, euro-franc moves are roughly equivalent to a 600-800 point move in the Dow.

Trying to end risk aversion mentality

What's behind the SNB's decision? Institutional investors and traders have been piling into the yen, Swiss franc, and dollar due to risk aversion -- the belief that markets across the world are not conducive for investment and/or aren't likely to generate adequate returns in the quarters ahead. The risk aversion move is considered a "flight to safety" until investment conditions improve. A rising Swiss franc is also hurting Swiss exports. The SNB's move suggests the bank is saying "the risk aversion trade can only go so far."

Risk aversion -- in plain terms, the unwillingness to invest/lend capital -- is one factor behind the financial crisis, and also is a factor in deflation -- a protracted decline in prices and wages.

Currency trader Andrew Resnick told DailyFinance Thursday that he views the Swiss central banks' move "as probably part of a continued, coordinated effort by the central banks to loosen credit."

"Conventional monetary policy [changing interest rates] has been tapped, so now they'll concentrate more on nonconventional tactics, including quantitative easing and interventions," Resnick said. "The Fed, ECB, Bank of England, and the Swiss are going to make sure we don't fall into a deflationary trap." Resnick added that he was stopped-out Thursday for a loss with a short trade in the dollar-yen pairing, and is presently flat, or has no open trades.

Don't fight the Fed, or the ECB, or the Swiss

Resnick said the Swiss intervention -- and the implied potential interventions by the Fed, ECB, BOE, etc. -- crosses-off the "pile into Swiss franc, dollar, yen trade." Those trades will no longer be slam-dunk winners, which will have the effect of "nudging capital back to other, riskier investments," he said, which is precisely what the world's major central banks want to occur.

"We expected a lot but the Swiss are not holding anything back," Christoph Rieger, a fixed-income strategist at Dresdner Kleinwort in Frankfurt, told Bloomberg News Thursday. "They're pulling out all the stops."

Forex/Economic Analysis: As trader Resnick noted, the major central banks' goal is to end the "risk aversion mentality," if not outright encourage institutional investors to start to deploy capital. It sends a clear signal that more liquidity is up ahead and that institutions basing investment decisions on risk aversion and the assumption of deflation could lose a lot of money. This will help loosen credit markets.

For U.S. investors, provided the other central banks follow through with sustained, liquidity-enhancing actions, the monetary policy is bullish for the stock market: it will provide more dollars for commerce, a critical factor in jump-starting the U.S. economy and economies around the world.

Read Full Story