Swiss FX Shock

On January 15, 2015 the Swiss National Bank (SNB) shocked the world with a surprise break away from the Euro peg which caused a cataclysmic revaluation of the relative value of the Euro and Polish Zloty.

Some context: During the summer/fall of 2011, in response to the European debt crisis the SNB stunned FX traders ~2.5 years ago when it announced it would peg it's currency to the Euro in an attempt to neutralize the Swiss Franc's (CHF) rapid appreciation due to its safe haven status. The SNB did this to protect the Swiss local economy which is 70% based on exports according to The Economist. Clearly, the SNB is no stranger to catching the market off guard.

As a trader I'm always interested in the circumstances surrounding these major announcements. Let's take a look at some of the relevant headlines from the 2011 European Debt Crisis.

Portugal’s $111 Billion Bailout Approved as EU Prods Greece to Sell Assets - May 16, 2011 -

Agency Cuts Greece’s Debt Rating Again -June 13, 2011-

Greece set to default on massive debt burden, European leaders concede -Monday 11 July 2011 -

Debt Contagion Threatens Italy -July 11, 2011 -

Global Finance Leaders Pledge Bold Action to Calm Markets - August 7, 2011 -

Swiss bid to peg 'safe haven' franc to the euro stuns currency traders - Tuesday 6 September 2011 -

5 Central Banks Move to Supply Cash to Europe - September 15, 2011 -

Clearly these were some hectic times in 2011. The headline risk was high as bad debt blowups lurked around every corner and Greece's default was all about assured. Let's look at how various markets were holding up then vs now. 

During 2011

In 2011 you can see ( TLT ) marching higher and higher all year, even after the surprise SNB peg to the Euro ~ 9/6/2011. Furthermore you can see the extreme appreciation of the ( CHF ) reaching ~30% in August basically forcing the SNB to act. Also of note, ( SPY ) tanked in late July, and increased volatility followed through November.

Current - 2015

Examining 1 year to today, we can see that ( TLT ) is similarly strong and gaining as headline risk increases. Of particular interest is the low relative volatility in ( SPY ) compared to 2011. Note however there was a market selloff prior to the current surprise SNB announcement. Look how big that   ( CHF ) revaluation is. 

SPX, FXF (CHF) daily log returns since 2010

Just to put the move in perspective the above chart shows the returns of the ( SPX, FXF ) since 2010. Talk about an outlier... 

The Bureau for International Settlements (BIS) triennial survey in April 2013 estimated that average daily turnover in the currency markets had reached $5.3 TRILLION! Factoring the size and breadth of the FX markets and the inherent leverage involved, a ~20% move in a major currency like the Swiss Franc is a major change in market dynamics that has wide reaching implications that aren't always immediately apparent.

Something like the Polish Zloty's ~20% decline vs the Swiss Franc could cascade into something bigger. According to Bloomberg News Poland has ~46% of total home mortgages denominated in ( CHF ) for a dollar value of ~$35 Billion. Imagine your monthly mortgage payment increased 20% overnight, would you be able to pay it? What would you have to give up to make good on your house note? This is the reality staring Polish citizens and banks in the face. My guess is a massive increase in bad debts, and asset writedowns are soon to follow. Accordingly, I'm not sure how much, if any of this is priced in equity markets with ( OIL ) dominating headlines and investor focus.

With that said I believe a bearish bias is prudent at this time as any 'unexpected' shock is likely to increase volatility in equity markets.  IMHO, the risk of the unexpected including: asset writedowns, profit warnings, bankruptcy's etc. likely resulting in margin calls, and forced selling; has increased dramatically. Be nimble, be adaptive, and manage your risk.