Source: Flickr user Gideon.
Trading in the U.S. stock market was relatively quiet for a change Thursday morning, with the Dow Jones Industrials (^DJI -1.78%) down just 77 points as of noon EST. The modest move was a nice break from the triple-digit roller-coaster ride that U.S. investors have had to endure recently, with gains from several sectors in the average overcoming further weakness among financial stocks.
The big news today came from the international markets, where the Swiss National Bank abruptly decided to allow the Swiss franc to float freely against the euro, causing a huge exchange-rate swing that could have a destabilizing impact on trade, at least in the short run.
What the Swiss did
Today's move involved removing a cap that the Swiss National Bank had imposed on the Swiss franc's value relative to the euro. For more than three years, the central bank had ensured that the value of the euro would remain at 1.20 francs or above. Yet SNB President Thomas Jordan said that the central bank "came to [the] conclusion that it's not a sustainable policy," simply removing the cap and allowing the franc to appreciate against the euro. And appreciate it did, as the euro briefly plunged to around 0.80 francs before recovering to the 1.05 franc mark as of 10:30 a.m. EST, and the Swiss currency gained more than 11% against the U.S. dollar after initial gains of as much as 25% right after the announcement.
The move reversed the SNB's decision in September 2011 to impose the cap, which caused similar controversy. At the time, Europe was in the midst of its sovereign debt crisis, and investors were feverishly looking for safe havens to protect them against a euro implosion. In order to protect the Swiss franc from becoming overvalued, the SNB effectively devalued its currency by linking its value explicitly to the euro, causing the franc to lose 10% of its value and stirring concerns that an all-out currency war could ensue.
5-euro note. Image source: ECB.
A lot has changed over that time period, though, to justify the reversal in policy. When the SNB imposed its policy, the euro was extremely strong as a currency, while the U.S. dollar was already weak and had threatened exports to the U.S. from Swiss companies. Now, though, the dollar has recovered strongly, sending both the euro and the franc down in relative terms. Ending the peg, therefore, has less risk of damaging trade with the U.S. now that the franc has already fallen so far.
Nevertheless, Swiss stocks collapsed in local-currency terms after the announcement. Switzerland has massive trade relationships with the rest of Europe, so strength in the franc will pose problems for companies like consumer-giant Nestle (NSRGY -2.83%), which declined 8% in local-currency terms today.
Yet for U.S. investors, the news could actually be quite good. Currency instability is the last thing Europe needs right now, so any negative impact on the economy there will hurt U.S. multinationals that do business on the continent. Still, by making the Swiss franc available as a safe-haven currency, the recent U.S. dollar strength could finally start to moderate, and that would help multinationals that have had to deal with substantial reductions in revenue and net income attributable to currency impacts.
Most investors pay relatively little attention to international markets, focusing close to home instead. In this case, though, what's happening in Switzerland could have dramatic effects around the world, and you should keep a close eye on the potential fallout from the Swiss central bank's move.
