What happened? Swiss franc Shock in 2015

Sometimes we forget that what happens in the financial markets does have a material impact on the man and woman who live everyday normal lives away from the fascination of the currency markets.

For many years Cyprus residents and also many residents from countries across the European Union have been taking advantage of very low interest rates that are offered by Swiss mortgage products to finance the purchases of immovable property.

However with the fall of the value of the Euro against the Swiss Franc mortgage holders have seen the benefits gained from low interest rates being eroded by the depreciation of the value of the Euro.

The event of January 15, 2015 have only made the situation worse as mortgage holders now have to struggle with a falling property market and negative equity values which are compounded by the Euro’s depreciation.

The size of the problem is not a small one with some EUR 3.7 billion in mortgages being borrowed in Swiss Franc’s.

Especially when you consider Poland that has a population of that is 40 times the size of Cyprus is concerned about is own USD 36 billion Swiss Franc mortgage overdose.

Central Banks’ job is currency stability

One of the main roles of a central bank is encourage market stability.

This stability is achieved by central bank’s giving both traders and investors warnings of possible future changes in monetary policy.

These notification can come in the form of “forward guidance” where the central bank gives a specific time scale of how it will make changes to monetary policy or by changing the tone of its language by making subtle changes when it gives a press releases or when it addresses analysts.

Forward guidance has been used a policy tool for some time by both the Federal Reserve in the United States and the Bank of England.

More recently the FOMC has dropped the term “considerable time” and replaced it with “patient” when it comes to its interest rate policy.

Only last week Mr. Mario Draghi the boss of the European Central Bank used the term “open ended” when he announced the policy to be implemented with respected to the Euro Zone quantitative easing program.

Traders and investors have got use to having information fed to them on a gradual basis.

Some of these market participants have become very good at reading between the lines of central bank speak and this has given them an edge when it comes to trading and investing while others just watch the news flow and participate in market volatility accordingly.

On January 15th 2015, the Swiss National Bank took the markets by surprise as they acted in a way which reminded me of the operations of national banks in the 80’s and 90’s when I worked on dealing desks in London.

What the Swiss National Bank Chairman Thomas Jordan did on that morning was nothing more than unleash financial shock and awe which sent investors and traders running for cover and left banks and some of our competitors either nursing some big losses or even closing up shop altogether.

SNB limits the value of the Swiss Franc appreciation

To understand what happened on January 15 need to rewind the clock back to August 2011.

Back then the Euro Zone was in the middle of a financial crisis which was making investors very wary about the future of the European project.

The unfortunately named PIIGS of the Euro area, Portugal, Italy, Ireland, Greece and Spain had dragged down the Euro due to the fears surrounding their substantially high debt levels.

There were also worries surrounding the viability of Europe’s banks.

The combination of this bad news led investors to seek a flight to quality.

The perceived safety and financial stability of the Swiss financial sector led investors to park their money into Swiss banks.

Traders at the same time also took large bets against the Euro as they sold EURCHF.

So what is the big deal?

The Swiss National Bank should be happy that its banks and Switzerland as a country is deemed to be a lake of tranquility when in the rest of Europe is in financial chaos.

Well it is not that simple.

Currency stability allows countries producers of goods and services to make long term plans which affect their ability to sell these products to the outside world.

For over a decade, Switzerland had looked on in alarm at the market driven depreciation of the Euro versus the Swiss France.

For Switzerland this is a major problem as this country although primarily known for its banking sector is also a producer of high value quality exports such as pharmaceutical products, time pieces and advanced technology equipment. Switzerland also earns considerable revenues from tourism revenues.

One only needs to take a look at the Big Mac index to get an idea how much more expensive the Swiss Franc has become since the SNB decided to take its action.

A Big Mac in Switzerland at today’s prices will cost you CHF6.50 which is going by the current exchange rate is a whopping EUR6.30.

Although my wife rarely allows me to buy fast food, I could go out today for lunch and purchase a Big Mac for EUR 4.00 and also get with it fries and a refreshing sparkling drink.

So we get it, Switzerland is expensive however back to August 2011 the Euro was in free-fall.

At one point it looked like EURCHF would start to trade under the 1.0000 level.

The very idea of EURCHF hitting parity was always going to be a step too far and this was when the SNB acted for the first time.

It had enough of European Union dithering and decided to buy the Euro in huge quantities as it bid to establish a floor at the EURCHF 1.2000 level.

What followed was a period of price stability for some 4 years as the pair EURCHF traded in a very narrow range around this 1.2000 price point.

SNB gives up on the Euro Zone’s leaders

Now let’s fast forward to January 15 when the Swiss National Bank announced that it would no longer try to defend the EURCHF 1.2000 level.

The SNB decided to take this action as it became apparent to them that trying to maintain the EURCHF 1.2000 support level would become very difficult if the European Central Bank as it was expecting would announce on January 22 a massive program of stimulus.

What was subsequently announced by the ECB Chief Mr. Marion Draghi was a stimulus package that would begin to pump Euro 60 billon per month into the Euro Zone area.

My gut feeling is the Thomas Jordon at the SNB got wind of was going to unfold and the speculation from unsubstantiated sources is that the ECB briefed him with respect to the scale of the Euro Area QE program.

If you add to this the political instability that manifested itself with an election that would ultimately put into power the radical left SYRIZA party in Greece combined with a ground swell of discontent that was coming from the citizens of other periphery countries meant that the SNB had little room to maneuver.

What followed the shock announcement by the SNB was a fall of the value of the Euro and collapse in the value in EURCHF by 30% to the low 0.8000 levels in the space of 30 minutes before it paired some of its losses and closed at 0.9750 on the day.

In the past few weeks EURCHF has appreciated somewhat as the market speculates the SNB is carrying out currency operations with an aim to stabilize the value of its currency.

With the SNB which was one of the biggest hordes of the Euro now discontinuing the purchase of the single currency it is now a case of when does the SNB begin to dump it’s over sized holding of the Euro.

In effect the SNB’s massive holding of the Euro has now become a downward pressure on the value of EURCHF.

What the Swiss National Bank has done has really shaken up the market.

Only time will tell if the SNB was wise or reckless.

However and this may be wishful thinking but just may be this action has done enough to get those in charge to finally take the tough decisions that the Euro Area has needed.

What is the aftermath of the SNB’s decision?

Trading of USDCHF and EURCHF

For traders of the USDCHF and EURCHF to participate in these currency pairs now takes on a greater deal of skill.

Opening positions in the Swiss Franc is now a much more risky affair because history tells us that the SNB will take no prisoners and does what it wants and when it wants to without any prior warning.

Therefore if you are going to try to trade EURCHF or USDCHF you better keep an eye on the news flow that comes out of Switzerland.

This includes news and comment from the SNB, Swiss Government and legislature.

As the main reason for the Swiss action back in August 2011 was to protect their exporters it is now important to monitor earning releases from companies that are traded on the Swiss SMI.

If these earning begin to dive the cacophony of disapproval that will be heard coming from the big Swiss corporations maybe just enough for the SNB to act once more to push down the value of the Swiss Franc.

Impact on Forex Industry

The Swiss National Bank has also unfortunately had a negative impact on some of our friends in the Forex Industry.

A few of these firms have been hit so hard that they have either needed to find fresh funds to take their liquidity back to normal levels while others unfortunately have had to close their doors and enter in voluntary receivership.

What actually happened is fairly easy to explain.

A Forex business that operates a “straight through processing” model acts as an agent to their clients.

That is to say that all client orders are passed onto the FX Company’s liquidity providers.

The FX Company does not take on any risk and earns commission on each transaction.

On the side of the liquidity provider their client is the Forex Company as this is who they have the legal agreement with.

What happened on January has been termed a black swan event.

That is to say that what happened on the day of the SNB decision was an event that deviated beyond what is normally expected and extremely difficult to predict.

Traders on the morning of January 15 turned on their computers as they contemplated the forthcoming news from the ECB and Greek National election.

Traders of EURCHF had got accustomed to trading within a very tight range around the 1.2000 level.

Volatility had dried up so much that the 14 period average true ranges was indicating that the normal trading range for that day was just 8 pips.

However what happened following the SNB announcement was huge range expansion that pushed the ATR level to some 467 pips in the space of 10 days.

This scenario caught traders, FX Brokers and liquidity providers unawares.

Traders who had taken long positions on that day saw their account balances wiped out, left Forex Brokers frantically trying to close positions as liquidity providers closed the tap as liquidity dried up.

It has been the norm for many years the traders would try to maximize their exposure to the market by using leverage.

In simple terms leverage allows an investor to trade an instrument size that is many times the size of this account.

For example some brokers offer leverage of 1:100 or 1:500 or 1:1000.

This actually means for every USD 1.00 you invest you are able to open positions which are the value of USD 100, USD 500, USD 1000.

This can be very rewarding when the trade goes in your favor however leverage can cause big losses too.

This risk can be managed under normal market conditions with logical order sizing and an understanding of the normal extent of the predicted range.

However on January 15 when the range expanded to unbelievable levels a combination of a 30% drop and leverage wipe out client accounts where traders had taken the long side of the trade.

Even with stops in place the lack of liquidity meant many investors could not get their stop orders filled.

The net effect was that client accounts end up with huge negative balances.

The Forex companies which were acting as agents up to January 15 thought that under normal circumstance that the risk was minimized under the STP model.

However such Black swan events where the volatility caused huge negative client balances meant that these brokers were now obliged to make good the negative balances which now resided with liquidity providers.

This meant that many Forex Companies that were impacted by their client’s losses found that the 8% capital adequacy ratio had been breached.

In light of this these companies had three choices.

Look for fresh investment to square up their balance sheets, request that the negative balance be made good by their clients or go into voluntary liquidation.

Many of these companies could not rise new funding and as for going for clients it would be a very difficult and time consuming endeavor.

Therefore the only option left open to these brokers was to take the hard decision and close down.

On the flip side many brokers that have implemented sound risk management practices which have limited the impact of excessive volatility.

This includes taking precautions such as increasing the margin requirement for A-booking Swiss Franc tradable pairs.

List of Forex Brokers