Happy (belated) Swissieversary, everyone!
It is four years to the day (yesterday) since the Swiss National Bank sideswiped financial markets with a shock decision to scrap its upper limit on the value of the franc, sparking some of the most violent moves in a major currency in living memory. To recap: the franc jumped by 26 per cent in less than half an hour. Fun times.
Even now, banks and investors are seeking to learn lessons from the horror show. Could it have been predicted? Did the market function properly? Was it fair game from the SNB? JP Morgan’s research institute has been seeking to find out.
Serious Swiss secrecy
The first rule of exchange-rate regimes is that changes in regime simply have to be secret, to avoid attracting a test from the market. To wit, the SNB was happily signalling its continuing dedication to the policy just days before the switch. In addition, it sprung the announcement as a genuine surprise. It was not a regular rate-decision or speech day. Did that make matters worse? Maybe.
JP Morgan reckons the impact of the decision would have been significantly smaller had the central bank announced its change of heart on the exchange-rate floor, which had been in place since 2011, at one of its regularly scheduled policy meetings, rather than pulling the minimum exchange rate out of the blue, it said.
“It would be reasonable to expect less overall buying of the franc and potentially less EUR/CHF exchange rate volatility just after the announcement,” said the authors of the report.
Hedge funds gonna hedge
Hedgies believed the SNB. Really believed it. Once the exchange rate floor had bedded in, they had absolute confidence in the word of what is, after all, one of the most highly respected central banks on the planet. They bought euros against the Swissie on a regular basis, effectively betting that the SNB would be successful and helping it do its job.
“Hedge funds’ confidence in the persistence of the SNB’s Minimum Exchange Rate policy appears to have peaked in the four weeks before the policy was removed,” the report said.
But the clue’s in the name. They hedged. In the immediate run-up to each of the SNB’s quarterly policy announcements, they generally reeled back those euro longs, JP Morgan notes. Just in case.
The US bank’s data shows that hedge funds routinely reduced and sometimes even eliminated their long euro positions going into regularly scheduled SNB policy meetings as well as speeches given by Swiss policymakers, to mitigate against the risk of the central bank pulling the floor. However, the December 2014 meeting of the Swiss central bank, passed with further reassurances that the floor would remain in place, leading these leveraged players to re-establish bets on a higher euro in both cash and futures markets.
This all left them buying Swiss francs, lots of them, once the floor was removed, to cover their losses.
That “could partially explain why hedge funds were buying large quantities of CHF in the three minutes after the policy was removed. Hedge funds losses were likely amplified due to the use of leverage,” says the report.
By the time London trading hours were finished, hedge fund buying of the Swiss currency outpaced sales of the franc by six times to one. Other investor types stayed out of the market during the move and period of dysfunction, participating in trading the franc only once the exchange rate stabilised.
“Had the SNB instead removed the EUR/CHF floor at a regularly scheduled quarterly policy announcement, hedge fund long positions in EUR/CHF may have been smaller, leading to less buying of CHF and therefore less volatility in EUR/CHF just after the announcement,” the report said.
If central banks are concerned with preventing market volatility (and it’s not necessarily always their day job) then:
“Our findings have implications for central banks as they consider how their choices with respect to communicating policy changes might impact financial market stability.”
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