January 15th, 2015 was a day that will go down in foreign exchange (FX) trading history as a day of infamy. The Swiss National Bank gave up the promise it gave to the market on September 6th, 2011. This promise was stated and reaffirmed as early as Jan 12th, 2015.
The Swiss National Bank or SNB was to defend the strengthening of the Swiss Franc or CHF by not allowing the CFH to weaken against the Euro to a level below 1.20.
Early morning on January 15th, 2015, the SNB came out with the following statement on their website stating they were dropping their 3.25-year peg.
“The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development. The Swiss National Bank is, therefore, aiming for a substantial and sustained weakening of the Swiss franc.”
What Caused the Currency Swing
Mass confusion reigned the morning the SNB removed the peg and cut rates causing the CHF franc, a historic Swiss haven that strengthens in times of economic uncertainty, to soar to unprecedented levels.
You may be curious as to why it was such a big deal and how so many were caught wrong-footed on this move. The following statement came from a high-ranking official of the SNB:
“We took stock of the situation less than a month ago (that’d be December 2014), we looked again at all the parameters, and we are convinced that the minimum exchange rate must remain the cornerstone of our monetary policy.” Three days later, the minimum exchange rate was pulled, and EURCHF dropped from 1.20 to an intraday low of 0.85, roughly a 41 percent drop.
FXCM, a popular retail foreign exchange broker, has a tool known as the Speculative Sentiment Index, that showed their clients were sellers of the Swiss Franc and buyers of EURCHF to a ratio of 67.3:1 before the announcement.
Considering the pair dropped 41 percent after the announcement, and many of these clients were leveraged in their positions, major losses for clients, and potentially the broker ensued.
How the Currency Swing Started
We learned that markets and their forces are stronger than any single central bank including the Swiss National Bank. To be fair, there have been multiple central bank program failures over the decades, such as the Thai Baht peg to USD in 1997.
While many central banks exceed in pushing markets around in the short run, in this case, the EURCHF 1.20 peg lasted for three years and cost a great deal and ultimately the cost was too much to bear as the EUR continued to fall in the wake of potential QE.
The Effects of the Currency Swing
As with most shocks to the market, the true impact took a while to come to fruition. Within 24-hours of the SNB announcement, a few smaller brokers closed shop, and there were reports of a few hedge funds having to close their doors because of unsustainable losses.
They were certain the EURCHF 1.2000 floor would hold and were accordingly levered long into an EURCHF, which dropped 41 percent today. Either way, the parting strategy for traders like you and me is clear. Some important things to remember are:
Leverage is always a risk.
Stops only limit losses. But, their prices are most often not a guarantee.
In the world of markets, there is no such thing as a sure thing, even if it’s a central bank’s word.