By Richard Sims
January 2015 ushered in unprecedented volatility in currency markets after the Swiss National Bank (SNB) removed its peg on the EUR/CHF pair (euro to Swiss franc).
Since 2011, the SNB has been dousing foreign currency markets with francs in order to minimize the overvaluation of the franc to the euro - a process that sprung from the government-debt crisis in Europe. On January 15, 2015 that peg was removed, and the resulting price action made fortunes for some investors; and crippled others.
The Original SNB Predicament
Most recall that the Eurozone Crisis was characterized by unsustainable sovereign debt across Europe coupled with slowing economies worldwide. Euro members like Greece, Spain and Portugal were no longer able to repay their debts, thus approaching insolvency and creating crisis situations for the eurozone as a whole.
The debts of these countries were downgraded to "junk" and they were forced to appeal to the European Commission, the European Central Bank and the International Monetary Fund for bailouts. (This trio of organizations has been called "The Troika" by some.)
As countries around Switzerland entered crisis mode, the Swiss franc's reserve status made it the target of investors looking to escape the euro and procure safety ahead of what looked to be a global recession - and it was.
The CHF was the only safe haven at the time because the Federal Reserve had already begun easing the USD, and loose monetary policies made investors skeptical. Similar fears existed toward the Yen as Tokyo was expected to intervene to devalue their currency.
So it was.
Investors began buying up the franc in droves - leading Goldman Sachs to report that from their perspective, the franc was 71% overvalued compared to what the fundamentals actually justified.
Still, investors doubted the efficacy of Greece's austerity plan in aiding the broader sovereign-debt crisis in Europe. Switzerland still seemed to be a bastion of neutrality and stability to many investors; and despite the coming recession, they were reporting positive economic data. The CHF was uncontrollably bullish as a safe haven asset amidst the crisis.
As economic conditions in the eurozone were failing, Switzerland feared that the "capital flight" into the franc would negatively impact the domestic economy, as 70% of Swiss GDP comes from exports.
Sure enough, the country began experiencing losses in its exports as Swiss products just cost too much abroad. The tourism industry weakened as well, and production costs began sky-rocketing with the rise in value of the franc. Notably, unemployment started climbing as companies were cutting jobs to account for revenue drops.
Swiss concerns about their own recession redoubled. In fact, because more than 50% of Swiss products are sold abroad, sales were hurt in most major Swiss industries. As an example, Emmental Cheese, a Swiss company and cheese exporter, reported a 17% loss on exports as the franc rose 25% against the euro and USD during the crisis.
BBC News reported in 2011 that German and French cheese imitations were undercutting prices by almost 50%. Imogen Foulkes of the BBC stated:
[anything] with a price tag in Swiss francs is being priced out of the market…
The SNB took preliminary measures early in the summer of 2011 to flood the market with francs, thereby increasing liquidity from SFr30 billion to SFr120 billion - 20% of Swiss GDP. The aim of the flood of liquidity was to drive interest rates into negative territory and discourage investors from holding francs.
But the crisis was too strong, and the SNB took official action to peg the franc to the euro.
The EUR/CHF Peg
On September 6, 2011, the SNB committed to buy "unlimited quantities" of foreign currencies, and to cut interest rates, forcibly controlling the overvaluation of the franc. Specifically, the bank would begin printing and selling francs (without limit) to keep the franc from exceeding 0.83 euros. The Swiss hadn't implemented such currency policy since the 1970s.
The peg worked, perhaps unexpectedly well. The franc tumbled, losing up to 9% in 15 minutes. Analysts said the move was larger than any currency fluctuations following the Lehman Brothers debacle, and most other geopolitical events that preceded the 2011 Eurozone Crisis.
Lowering the Swiss interest rates with Libor was also tactically instituted to continue to discourage foreign investors from holding francs.
Since it was put in place in September 2011, the ceiling was only broken once. That happened on April 5, 2012. It was short-lived.
The furor stirred what some have called currency wars. The Wall Street Journal reported that hedge funds were attempting to battle the peg by aggressively buying up francs; but to no avail.
Switzerland, between 2011 and 2015, had expanded its balance sheets to account for 80% of GDP at one point. By comparison, the Fed has expanded its balance sheets to 25% of GDP previously.
Jan 15, 2015 and the Biggest Currency Shock in Recent Memory
The SNB had reiterated its peg just a month before removing it on January 15, 2015. The reasons for lifting the peg are:
- They expected the ECB to implement Quantitative Easing in the Eurozone - which they did;
- As the euro declined in value in 2014, so did the franc; it only made sense to counter-act the ancillary devaluation of the franc;
- Some speculate that political pressures like the gold referendum vote in November led the SNB to start shedding some of its currency, as they were holding an estimated $556 billion in foreign assets. Politicians feared Switzerland's balance sheet was too entangled in foreign assets.
As a measure against volatility from unpegging the EUR/CHF, short interest rates were cut further from -0.25% to -0.75%. The effort didn't do much.
On the day of the announcement, the franc increased 30% against the USD, and closed up 23% against the euro. Global markets were shocked by the surprise SNB move, and investors lost and won with equal magnitude.
Winners and Losers
Here's a list of who exited before the move, who was deeply damaged and who profited on January 15, 2015.
Click on the links to be re-directed to more information about how the SNB's decision impacted these firms.
UK FX broker, Alpari instantly became insolvent. FXCM, based in New York, owed $225 million as a result of clients' negative equity.
Others profited massively in the move. Business Insider reports that Quaesta Capital AG was up 14% with help from the SNB. Lynx Asset Management gained 2% the week of the unpegging.
The consequences of this unprecedented move by the SNB are only just becoming clear to markets. The event was monumental, and investors all over the world will take powerful lessons away regarding leverage, safe havens and, so called, "currency wars."
The road ahead for the SNB might be rocky as it appears the euro is headed into another recession. How they will handle the current crisis is anyone's guess. Few are believed to have anticipated the reversal by the SNB.
For investors, one tenant is all too clear: an efficient market can be a brutal market, depending on what side you're on.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.