Swiss National Bank Defends Currency Peg, Cites External Pressures

On Thursday, the Swiss National Bank (SNB) reaffirmed its stance to peg the Swiss franc to the euro at 1.20 and left the country's borrowing costs at 0%. These actions were intended to prevent the European Debt Crisis from derailing the Swiss economy.

The Swiss National Bank pledged in August 2011 to buy unlimited amounts of euros, so as to keep a ceiling on the Swiss franc versus the euro. Before this pledge, the strong Swiss franc threatened to drive the export-dependent Swiss economy into a recession and capital flight from the Eurozone was only fueling the franc's strength.

SNB President Thomas Jordan said Thursday that the bank would defend the peg "with the utmost determination." He added that Eurozone fiscal challenges have worsened seriously over the past few months, and he fears increasing upward pressure on the franc. He continued, "Switzerland will experience a significant economic slowdown over the rest of the year. The risks for the Swiss economic situation remain exceptionally high."

Market observers have seen Switzerland's extraordinary policy play out in the currency markets. Traders can use the peg to their advantage by going long the EUR/CHF when it trades below 1.2010 with stops at 1.2001 (just above the peg), targeting a gain of just 10-25 pips. These traders can likely sell out, wait for it to drop back, rinse, and repeat.

The European Debt Crisis is affecting Switzerland. Resultantly, the SNB is attempting to hedge its euro exposure by diversifying into other currencies, including the Korean won. Investors may attempt to front-run the bank here by building won exposure.

In addition, the European Debt Crisis has entered a new phase. While investors await the outcome of the June 17 Greek election, financial conditions continue to deteriorate in Europe. Peripheral bonds are suffering as yields climb. Moreover, the potential of a Greek exit, caused by the country's inability to form a government, looms large over markets.

As the public must wait to see the results of the upcoming Greek election, select insiders and institutions may already have more information. Television and print media have reported that hedge funds and other large financial institutions are hiring individuals to poll Greek citizens ahead of the election. This polling has occurred because the media are not allowed to poll Greek citizens this close to the upcoming election.

At the same time, a Greek bank run continues, with daily bank withdrawals now amounting to more than 1 billion euros per day, according to some estimates. The slow drain of assets from the Greek banking sector has kept it from a quick collapse. However, this drain leaves the sector potentially vulnerable to a euro exit. If Greece were to exit the euro, all deposits would be re-denominated into new drachmas. The currency would most likely fall, wiping out lots of wealth from Greek bank accounts and also increasing the strain on the banks.

If upcoming European events go sour, traders will test the SNB's commitment to the Swiss currency peg. Lacking a government in Greece, the euro may sell off and put pressure on the peg and thus, the SNB. This weekend will surely be a fun one. Good luck and good trading.