One of the greatest bluffs in financial history was pulled over the last week. I’m referring to the Swiss National Bank’s “No Peg” decision this morning in Zurich. What’s amazing to me is that the bluff was just that, a bluff.
This started with a middle level guy at the SNB saying that “All options” were on the table to deal with the staggering appreciation of the currency. He included a fixed rate peg in that mix of options. The SNB spoke to all the press. The SNB spoke to market participants. They flat out told everyone that a peg was coming. They lied bluffed.
The notion of a fixed peg for the CH is the stupidest thing they could have done. At some point events would evolve such that Franc would come under speculative attack. That could break the back of the SNB and send the EURCHF 15% lower in a day. This is the Alamo approach. We remember how the Alamo ended. The SNB knew that a peg was a “risk all” bet. I’m sure that they also knew from their own experience and advice from other Central banks and Treasury types that the line in the sand (peg) was a way to make speculators fantastically rich.
I’m of the opinion that there never was any serious consideration for a peg. It was just noise. In support of that view I provide a personal perspective.
Way back in 1992 I was running a modest slug of leveraged capital. This was a Macro approach. By that I mean we played in major markets looking for big relative changes. Availability of leverage was key to success. FX is max-leverage if you have capital. It was no problem to trade interbank FX and put up only 2% margins. At that level one could have a $1b currency position and it would only require 20mm to play. (There would have to be back up equity available)
Currency markets often move 2% in a day. So the possibility to make (or lose) 100% of your stake in a few hours was a regular event. And that is what I did. Functionally, a $25mm bet. Double it (or more) or lose it in a less than 72 hours. I was a percentage player; this was intoxicating stuff.
One day I get the call and the voice says that George Soros (led by Stan Druckenmiller) was shorting the shit out of the British Pound. That sounded like fun to me, so I joined the fray.
The rest is history. On September 16th 1992 (Black Wednesday) the Pound was devalued. It was very well publicized that Soros made a billion+ on his trade. He broke the Bank of England. My involvement was small compared to George S. I was not the only one who jumped on the Soros bandwagon. The cost to the UK Treasury came to $5 billion. The Soros share was only 20% of the total. Let’s say we all got fat.
All the global CBs were very pissed off about this. It made them look stupid. What Soros (and I/others) cleared was directly off the back of the BOE. Our gain was their loss. The UK/global press had a field day with guy who ran the show at the BOE, “Robin” Leigh-Pemberton. (perfect, no?)
This was a very big deal for the CBs. There was a great deal of internal and external discussion. It went on for years. There was a bottom line conclusion that all the reserve currency central bankers came to:
They could never put themselves in a position on currency intervention where there would be a firm commitment to defend a given exchange rate. (a peg)
The lesson of the devaluation of the Pound was that markets (and big market players) were bigger than the resources of even the Bank of England.
From that point onward there has never been a repeat of the fixed exchange (peg) approach.
CB’s like the SNB and Bank of Japan have been intervening for years. The strategy is always the same for these two. They have played defense. From time to time those CBs have come out from under a rock screaming and yelling and spreading rumors. On many occasions they have resorted to splashy interventions. But that is just noise. The only objective of these central banks has been to slow the inevitable.
The current head of the SNB is a very nice fellow. Mr. Phillipp Hildebrand. He is an Olympic swimmer. He is a hero in Switzerland for his efforts in the pool. But he’s not a central banker, and he should not be running the show at the SNB.
There are many good former central bankers in Switzerland. There are also a few in Germany who have watched/participated in history. I’m absolutely sure that while Mr. Hildebrand was talking to the press about his idea for a peg, he was also getting some advice from some smarter sources. Who knows? He might have even gotten some input from his friend, DSK. (also perfect)
All of the CBers (both past and present) would have told Mr. H. the same. A peg is a modern day no-no for a reserve currency. That lesson has been learned. One time is enough. Hildebrand should have known this himself. If he didn’t, he shouldn’t have the job. He should never have initiated the peg talk. The “peg talk episode” will be his black eye that stays with financial history.
There is no Peg. There is no intervention. So why the hell is the EURCHF at 1.14? Easy. The SNB has flooded the market with CHF. They have increased cash liquidity from 30b to 300b in a week. That is a ten-fold increase. The increase is equal to~50% of GDP. If something like were to happen in the US or Japan there would be some form of explosion. It’s just too much money to hit the system.
As a result, Swiss deposit rates have turned negative. This is reflected in the swaps market. If one wants to be Long Swiss and Short the Euro the position must be rolled over in the swaps market.
The cost of a short EURCHF has become very big as a result. The current spot rate for EURCHF is 1.1400. The six-month forward rate is 1.1270. In other words, the currency pair has to move by 1.1% just to break even. When the equity is only 2% it means that the financing costs eat up more than 50% of your capital behind the trade. Specs don’t like that action.
I’m taking a wait and see for a bit. It’s better to find something else to do than trade the Swissie until the swaps settle down (they will).
It’s impossible to forecast the timing of currency moves with any precision. But I will say that the way the SNB has handled the past ten days has made it a certainty that there will be another big speculative move into the CHF at sometime in the future. I would say sometime late fall.
I say that because the massive increase in liquidity can’t be maintained without consequence. I say that because the SNB has shown a very weak hand. They tried to bluff their way out of a tight spot. They may have bought some time. But that is all they have bought. They have hung a new sign on the SNB headquarters.
We were bluffing
We are just playing defense
We are vulnerable
PS. Sorry for all these bits on the CHF of late. This has been an interesting tale for me to tell.