A remarkable day on the currency markets

In one of the most remarkable days in the foreign exchange
market for at least 20 years, the Swiss franc rose by an
astonishing 30% against the euro in a mere five minutes. This is
as a result of the announcement of the Swiss National Bank
(SNB) that it was ending its policy of pegging its franc to the euro
at a minimum rate of 1.20 Swiss francs per euro.
It seems to have caught many market participants by surprise as
witnessed by the frenetic and chaotic trading following the
announcement. At one point shortly after the announcement the
Swiss franc was trading at a mere 0.75 to one euro before
settling at the 1.02 francs per euro later in the morning.
Such large currency movements normally take many months or
even years to occur but have been packed into a single morning
of forex trading. The movements on Thursday can be seen in the
candle chart below. Each candle represents five minutes of
trading with a red candle indicating a strengthening of the Swiss
franc and a green candle a weakening. The wicks of the candles
indicate the high and low of the trading during the five-minute
interval.
Keith Pilbeam, Author provided
How we got here
In September 2011 the Swiss National Bank was worried about
the implications of the ever-strengthening franc for the economy,
and its exporters indicated that it would not tolerate a rate below
1.20 francs per euro.
Importantly, the bank also indicated that it would be prepared to
print unlimited quantities of Swiss francs and buy euros to
ensure its target rate was not breached.
Such an announcement is highly credible in the financial markets
and this can be seen by the fact that following the September
2011 announcement the Swiss franc moved swiftly from 1.10
Swiss francs to the euro to above the 1.20 level within seconds.
That level has not been breached for more than three years –
until now.
The problem is that the policy has caused a massive amount of
liquidity, pushing up Swiss property prices and asset prices such
as stocks and bonds and causing record low interest rates. It
has also meant that Swiss foreign exchange reserves have
nearly doubled from around 275 billion euros to more than 500
billion euros equivalent.
When a market explodes
The movements show what can happen when a rigged market
finally blows up. The fall-out from this sudden movement is
likely to be huge. In the short term, there are going to be both
large losses and profits for some traders, banks and hedge
funds – and some of the losing parties could be in real trouble,
being forced to sell other financial assets such as stocks and
bonds to cover their losses.
There could also be a fear of other abrupt movements on the
part of financial market participants, leading to a flight to safety
(into German bunds, US treasuries and gold) and a sell-off in
what are deemed to be risky assets such as low-grade corporate
bonds. Banks and multinationals will reappraise the currency
risks they have on their books.
The abrupt movement will also pave the way for quantitative
easing by the European Central Bank later this week which would
further weaken the euro. In the longer term, the stronger Swiss
franc will certainly hit the export earnings of major Swiss
companies and lower their profitability. This latter possibility has
already been reflected in a fall of more then 10% in the Swiss
Market Index which measures the value of Swiss shares.
Such turbulence in the foreign exchange market has a history of
affecting economies several months later. One can think of the
Thai baht devaluation of 14% in July 1997 that preceded the
Asian financial crisis of 1998. There is also the case of the sharp
appreciation of the Japanese yen against the euro and dollar in
August to October 2008 that was associated with the global
financial crisis.
The recent collapse of the Russian rouble and the Swiss franc’s
movement may well lead to a heightening concern about
emerging market currencies that could be subject to speculative
attacks. Such concerns will most probably result in a delay in
interest rate hikes by countries such as the United States and the
United Kingdom to much later in the year.