The Badger of Broad Street on the Swiss shocker

2015 came in like a lion and has stayed that way. Oil prices, bond yields and stock crashes in China are just some of the factors we’ve struggled to get our heads around. Already it’s proved pretty brutal for many market players, wrong footed by volatile markets in the first week of the year and then caught by the Swiss Central Bank ending the Euro collar during the second.

The Swiss move was a classic “No-See-Em”: a market event that catches everyone completely by surprise, but with hindsight was blindingly obviously about to happen.

A number of Harry Hindsights claim to have spotted the inevitability of the move – but were they actually invested for a massive CHF leg-up? I wonder who was, with a senior Swiss central banker telling us just a few days before that the 1.20 cap was sacrosanct, who would have expected it? But we probably should have. How do you know a central banker is being economical with the truth? Because his lips are moving…

The Swiss have been spending billions of freshly minted francs on keeping the CHF at 1.20 to the Euro. They sold Swiss francs to buy Euros, which they have then invested in European sovereign bonds. Which means the Swiss were increasingly exposed to a weaker Euro causing a massive loss on their bond portfolio – and the Swiss electorate tends to be very concerned if their Central Bank is losing money!

If, as is widely expected, the ECB announces a massive QE programme on Jan 22nd, that’s likely to further weaken the Euro, putting further pressure on the Swiss to support the Euro vs CHF. All central bankers know they can fight financial gravity for a short time – but they also know it’s a battle they never ultimately win. The collar had been in place for 3 years. It lasted longer than most.

The sudden ending of the collar caused the Swiss franc to stage an extraordinary rally, catching everyone who’d bet on the CHF remaining at 1.20 and causing extraordinary losses. As FX is seen as a low risk game, players are highly leveraged. 20 times leverage means a 5% loss can wipe you out. As the CHF spiked by 25% they were carting out bankrupted players through the day.

We’ve heard banks have lost 100s of millions, hedge funds have been closed and there are stories of stop-outs and margin calls being missed by thousands of retail investors.

The markets are not well positioned for such pain and anguish. As a result of the losses, many firms have been forced to sell their stronger assets, making some parts of the market look cheap. The Swiss move was a shocker, but how many others wait in the wings? Markets aren’t that imaginative, so the Danish kroner has been the subject of speculation as folk wonder if it may break its Euro reference links. Or, what other central banks may shock and disappoint us?

Perhaps the ECB is next up? Its problem isn’t surprising us, quite the contrary. It seems genetically incapable of actually doing anything. And therein lies the problem. If the ECB fails to meet the markets expectations of kitchen-sink QE, then the markets will view it most unfavourably. So we’re uncertain whether that particular can gets kicked down the road again. The problem is, the markets will lose their patience with the Euro before the ECB is able to backslap itself for the crisis passing.

So where does that leave us in terms of the trade of the week?

Still reckon its time to buy dollars.

Badger