By Admiral Markets
How often do Black Swan events occur?
In the last decade, those rare, unanticipated events that seem to turn what we know on its head have been surprisingly frequent.
Far from being once-in-a-generation occurrences, in just the last ten years we have seen:
- a global financial crisis
- the rouble rout
- plunging oil prices
This article is about just such an event, but revolving around an unlikely culprit:
…the Swiss franc, the currency of Switzerland, abbreviated as CHF.
The Swiss franc, so often seen as a safe haven, became the most risky asset in the Forex market for a brief while in early 2015.
This happened when the Swiss unpegged the franc from the euro.
We will look at the story leading up to this momentous event and the reasons that lay behind it.
How the Swiss franc became a victim of its own success
The Swiss franc makes a good example of how the behaviour of market participants alters market conditions.
You see, it was precisely because of the official currency of Switzerland’s reputation as a safe haven that it eventually became a hotbed of volatility.
Let’s flip back the pages of our calendar a few years and delve into the dark days of the global financial crisis.
The tightening of liquidity and sudden halt in economic growth around the world pressured many governments into instigating bank bailouts.
This increased the level of sovereign debt.
Some of the more stressed economies in the eurozone found they were unable to repay or refinance their debt.
The ECB stepped in to assist these countries with bailout funds, but the effect was deleterious for the euro.
Other beleaguered countries could seek to rectify their problems by a unified combination of monetary and fiscal policy.
In the eurozone, however, there was one unified monetary policy alongside a variety of different fiscal structures.
At the same time, European banks tended to hold large amounts of sovereign debt.
This meant there was a kind of feedback loop at play:
- fears that certain governments might default on their sovereign debt negatively affected banks throughout the eurozone
- this, in turn, fed back to further stress eurozone governments who were committed to protecting these banks.
What was the upshot of this?
The euro was on a downward curve, its central bank struggling to deal with the faltering economies.
In short, the euro was looking unattractive.
The Swiss franc (CHF), on the other hand, was looking more and more appealing.
Investors were desperate to find a safe place to funnel their funds amongst the economic turmoil.
The Swiss franc seemed to fit the bill.
The prevailing view was that the official currency of Switzerland was less risky than many other assets:
…overseen by a sensible, stable government and a central bank unafflicted by the debt troubles that racked the eurozone.
Naturally, the euro weakened and the Swiss franc strengthened.
The weaker euro started to cause concern at the Swiss National Bank (SNB), however.
On 4 April 2011, EUR/CHF was trading as high as 1.3242.
As we can see from the daily chart above of the Swiss franc exchange rate against euro, that value steadily declined over the next few months.
On 3 August 2011, the SNB complained that the Swiss franc was ‘massively overvalued’.
In addition, the central bank announced it would increase the supply of liquidity to the Swiss franc money market.
The value of the euro against the Swiss franc continued to sink, though:
…by 9 August, the rate was all the way down to 1.0066, barely above parity.
On 17 August 2011, the SNB complained again in a statement that it viewed its currency as ‘massively overvalued’.
The statement detailed a number of measures intend to depress the value of the franc.
Significantly, the central bank closed with a warning salvo that it would go further if deemed necessary.
Why was the SNB so against a strong Swiss franc?
Switzerland is in the top 20 when it comes to world economies ranked by size of exports.
Like all export-reliant economies, Switzerland starts to feel the pain if its currency becomes too strong.
Exports like Swiss watches are naturally priced in Swiss franc denominations and a strong franc starts to hinder demand.
Furthermore, Germany is Switzerland’s biggest export market.
The EUR/CHF rate is of particular importance, therefore.
Added to this, such a situation comes with deflationary risks:
…as Switzerland’s money became increasingly strong, so did imports become increasingly cheap for Swiss consumers.
This created downward pressures on consumer prices as a whole.
If consumers notice that prices are falling, they may hold off purchasing today in favour of purchasing tomorrow…
…which then contributes further to the deflationary cycle.
The SNB’s tough words had a temporary effect.
EUR/CHF rose almost to 1.20 at the end of August, but by early September was once again dipping.
The SNB had warned of further measures if necessary.
On 6 September, it was true to its word:
…the SNB pegged the franc against the euro, raising fears of a devaluation war.
So how did this peg work?
The SNB promised that it would buy ‘unlimited quantities’ of other currencies in order to lower the relative value of the Swiss franc.
The central bank drew a line in the sand at CHF 1.20 per euro.
It would not allow the value of the Swiss monetary unit to appreciate beyond this level.
Effectively, it was a Swiss franc devaluation.
An intervention on such a large scale sent waves through the FX market, as the daily EUR/CHF chart below shows:
The move was successful insofar as it achieved a big decline in the value of the Swiss franc against other currencies.
That day, EUR/CHF jumped as high as 1.2194.
Though it finished the day close to the 1.20 threshold…
…we can see that the EUR/CHF rate was higher in the following days.
In fact EUR/CHF stayed above 1.22 for much of the rest of 2011.
This was not to be the last Swiss currency shock delivered to the market at the hands of the SNB, however.
Analysts struck a cautionary note, warning that the central bank’s resolve would be sorely tested if the eurozone debt crisis deepened.
But the years rolled by and the eurozone crisis kept rolling along also…
…and the peg held for that time.
And those cautionary words were forgotten.
We now fast forward to January 2015.
Swiss central bank move rocks currency
If Swiss Forex traders were stunned when the SNB introduced the peg…
…there was nothing short of panic when the central bank unpegged the franc without warning.
Why was it so unexpected?
Of course, there is always the chance of unexpected news in the market.
Central banks, though, usually try to calm the market rather than stir it up.
Though they do intervene in the currency markets from time to time, there are usually hints that foreshadow such action.
This helps to mollify the response when they finally do make a move.
Not so this time.
In fact, it was the diametric opposite.
On 12 January 2015, Jean-Pierre Danthine, the vice-chairman of the SNB, went on television and said:
“We are convinced that the minimum exchange rate must remain the cornerstone of our monetary policy.”
When, three days later, the SNB did the exact opposite, it was a complete surprise to the market.
The response was dramatic.
The daily EUR/CHF chart above shows just how extreme the move was.
The large red bar dominating the chart represents the day the SNB unpegged the Swiss franc from the euro.
The day began with the cap held above 1.20.
When the SNB pulled the peg, things moved extremely fast and extremely far.
At one point during the day, the rate plunged below 0.83.
That’s a drop of more than 30%.
Nick Hayeke, the CEO of Swatch, described it as a ” tsunami” for the entire country.
Let’s look at the reciprocal of these numbers, which shows a peculiar kind of symmetry:
At the beginning of the day, one Swiss franc was worth 0.83 euros.
At the most extreme end of the swing on that same day, one Swiss franc could be exchanged for 1.20 euros.
It was a complete inversion of fortunes for the two currencies.
The sudden gain in value of the Swiss francs currency was not only against the euro though.
If you look at other currencies, you will see similarly outrageous spikes in the charts at the time.
For example, if we look at GBP CHF exchange rate history in 2014 to 2015:
GBP/CHF fluctuated between extremes of 1.5545 and 1.1865 on the day in question. This was a move in value of roughly 24%.
The range for the whole of 2014 was little more than 1000 pips.
This was more than three times that amount in the space of a single day.
Clearly sparking, such volatility was not desirable for the SNB, so why did it remove the peg?
Well, to understand that, we have to quickly look at how the SNB defended the peg in the first place.
The central bank capped the value of CHF by creating new francs and using them to purchase euros.
This tightened the supply of euros while increasing the supply of francs.
That policy was successful in maintaining the peg for a good few years, but there was an inevitable consequence:
…the SNB vastly increased its reserves of foreign currencies.
By late 2014, it had accrued so much that it represented around 70% of the Swiss GDP.
There were questions about how tenable it was to keep increasing these reserves of foreign currency.
More importantly was the way things were shaping up in terms of the ECB’s monetary policy.
At the time, there was strong expectation that the ECB would soon unleash some kind of quantitative easing (QE).
Such a move would apply huge downward pressure on the euro.
Once the ECB did that, the SNB would be forced to expand its balance sheet even further if it wanted to maintain the peg…
…and potentially become mired in ECB monetary policy.
By removing the peg, the SNB was effectively conceding that it was outgunned when it came to printing money.
Yes, it took a big loss on its holding of foreign reserves as the franc appreciated.
However, these losses would have been even bigger had it swelled those reserves further and deferred its exit strategy.
This is because expectations turned out to be correct:
…the ECB launched an expanded asset purchase programme to the tune of €60 billion just a week later.
All the charts in this article are from MetaTrader 4.
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Preparing for the unknown
It has been an extraordinary time since the financial crisis.
Banks around the world have been stretched to the point of breaking.
In response, central banks have created vast amounts of money to prop up their ailing economies.
And on top of this, a number of unrelated price shocks have cropped up every so often.
As we’ve seen from this article, at such times prices can move violently.
That is the nature of the unexpected.
Want to hear the good news?
Just because something is unexpected, it doesn’t mean you can’t prepare for it.
Practicing your trading with real market prices can help you get a feel for how to deal with unexpected adversity.
It allows you to see what works and what doesn’t work when you are up against it.
This is why our risk-free demo trading account is so useful.
After the peg: a new era for the Swiss franc
Stability is the keyword when it comes to much of the Swiss franc history.
That notion, though, has been somewhat turned on its head by the events of the past few years.
The unpegged CHF marks a new chapter in Switzerland’s FX history…
…when a supposedly safe currency delivered a price shock to the market.
Since then, the tenor of Swiss franc wiki pages around the world have been substantially amended to reflect this new normal.
Beyond the concerns of the FX trader, there have been wider implications for the Swiss people.
Areas of the economy that have been impacted by a stronger franc include:
- trade unions
Deflationary fears were not unfounded:
…Switzerland’s CPI was -0.49% in January 2015, on a year-over-year basis.
This had worsened to -1.31% by December 2015.
At the time of writing, EUR/CHF has not come close to testing 1.20 again.
If you like this article, why not read about other FX pairs, such as our pound-dollar history.
Article by Admiral Markets
Admiral Markets is a leading online provider, offering trading with Forex and CFDs on stocks, indices, precious metals and energy.