The Swiss National Bank, Switzerland’s central bank, has shocked markets by abandoning the Swiss franc link to the euro which attempted to cap the value of the franc to the euro.
It caused unprecedented volatility in currency markets. Richard Franulovich, Westpac’s currency strategist in New York, said that “EUR/CHF collapsed from just above 1.20 to a low around 0.80, though there will of course be some doubts about the veracity of these rates”.
“USD/CHF fell from around 1.0220 ahead of the announcement to a low of 0.7302, reportedly. As the dust has settled EUR/CHF is trading at 1.0310 while USD/CHF is trading at 0.8865.”
But the real impact of this Swiss Bank move is the uptick in volatility it has caused which will increase the risk of carrying positions (as measured by bank value at risk models), which in turn will undermine risk appetite in markets completely unrelated to the Swiss franc and even currencies, with Franulovich noting:
Value at risk (VAR) levels will be surging thanks to the extreme move in CHF, coupled with high and rising volatility in other asset classes, most notably commodities in recent days. As a result asset managers of many stripes will be forced to liquidate risk/positions. For G10 FX, favoured positions have been long USD / short AUD, CAD, EUR and NOK. The initial move in G10 FX will thus be position driven and the likes of AUD, CAD, NOK, EUR, et al should firm in coming days, perversely given higher levels of volatility typically weigh on these currencies.
The forced liquidation of positions following the collapse of Lehman’s played out of over many weeks and in many seemingly unrelated instruments across financial markets. We should expect the same, though to a much smaller degree.
Franulovich suggests this is a mini-Lehman moment.
But there is every chance that this is the Minsky moment of 2015. As I wrote in my Go Markets Asian wrap yesterday afternoon:
From my experience, two-way volatility eats away at the confidence of traders, because both longs and shorts can get stopped out and still be ‘right’, and this in turn undermines the market’s structure and resilience leading to smaller positions held with less conviction. This then often is the precursor to and sets the preconditions for a big swing, even a crash, more possible. Imagine a spinning top in those final uncontrolled spins.
This kind of volatility freaks most traders out. The Swiss National Bank might just have undermined the fabric of markets and traders.
This could get ugly.