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 per cent against the euro in a mere five minutes. This is as a result of the announcement of the Swiss National Bank 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 €1 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.
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 both Swiss francs and 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 to more than €500 billion 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 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 per cent 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 per cent 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 US and the UK to much later in the year.