“Our problem is that the power of thought enables us to construct symbols of things apart from the things themselves.”
Commentary & Analysis
Swissie comments-it is all connected out there
Commentators of all stripes are weighing in on the Swiss franc move/debacle/etc. Many talkers don’t really trade currencies; some do…here is brief bullet point take:
1) As soon as the Swiss National Bank decided to peg its currency against the euro, one-way risk was created. What I mean by that is central banks have to protect pegs, when it gets expensive they can no longer protect it, so they take them off. Removing the peg against the euro, given the market weakness and negative sentiment towards the single currency meant a whole bunch of bottled up one-way risk.
a. So why go long or short the Swiss relative to the euro (when there was not much gain given the peg’s limited volatility unless you were playing the game with a massive amount of capital)?
b. So why go short Swiss against the US dollar when you had a better alternative—the euro? Going short the Swiss against the dollar or euro meant you were exposing yourself to that one-way risk set up by the central bank.
2) Did I predict this would happen? No. I did know at some point as pressure built SNB couldn’t maintain it and shared that in past talks; but I had no clue when that would be. A few days before the lifting of the peg, the SNB assured everyone all was good. So confidence what high the peg would be maintained despite rising cost to the SND.
3) There were in fact some major investment firms warning its clients it was increasingly costly for the SNB to maintain the peg and risks were growing. As recent as January 8th, Morgan Stanley (a firm that does a great job on currencies) warned it clients they may want to consider hedging any short Swissie exposure and said short holding a short EUR/CHF positions could make a very big—producing some nice profit--if the peg was abandoned (ditto $/Swiss).
4) Was this a Black Swan event? No. If one can see the risk, and define a rising probability of the same, it doesn’t qualify as a Black Swan event.
5) Does it mean currency trading for the small player is a no go? No. It only means there is real risk in this market (no surprise) and the more leverage you personally choose to use the more you expose yourself to said risk. Did people stop trading in emerging markets when Russia defaulted on its bonds back 1998? No. Did the 1987 US market crash mean people should stop trading stocks? No.
6) Regulators are licking their chops. In retrospect, regulators have done a good job cleaning up the many bucket shops and charlatans that populated the retail forex industry. The firms have improved with better systems and tighter spreads. The industry has consolidated because of more strict capital rules. But the concern is regulators will now overreact to this event and in doing so create the usual unintended consequences of making FX more inaccessible to the retail player, under the guise the regulations they are imposing will make it “better” for the retail player. We await this fallout.
For the record, Black Swan did not have a position on in the Swiss franc. The last trade we suggested to our clients was back in May 2014; it was a long position against the dollar (and it was a losing trade). From that point going forward (May 2014) we stopped doing research on the Swiss completely, because of the reasons I indicated above—I wanted our clients nowhere near it. To say again: I knew I couldn’t predict when the peg would be removed, so why be short the Swiss when the euro alternative was better?
Now, if I knew what I knew why didn’t all those powerful funds know this? Well, they did. They just took a risk and got burned. That happens. Stuff like this happens in markets, albeit not quite this dramatically. But sadly, the individual traders didn’t seem to know their risk and it seems got no help from where they were trading, given the amount of damage reported. And surprisingly, it seems some of the retail firms offering FX who got whacked didn’t think enough about this exposure to hedge their client risk or limit Swiss trading altogether, etc.?
I know after the fact, sitting on the couch in one’s living room, sipping an adult beverage, in the calm light of day everything is easier to see. But this was no Black Swan event. It was a dramatic event and sadly it burned a bunch of good people.
I do agree with those who believe the impact from this is still reverberating out there still.
For example, Polish mortgages (and Hungary to a lesser degree because they started cleaning up the problem before the peg was lifted) denominated in Swiss franc will hurt the Polish economy and its banks, and maybe larger euro banks who offer credit lines to Poland (Hungary). And this comes at a bad time, as you know the Eurozone is already reeling and the Russian Bear is on its hind legs.
The Asian (emerging market) crisis (intensified by the Russian bond default in 1998) was the trigger for contagion globally back in 1997-98; eerily similar because of Asian debt denominated in US dollars and Russia on the ropes. Already we know emerging markets are under severe pressure given the size of their dollar denominated debts and the shrinking ability to attain US dollars (major players are reallocating structurally out of the euro and into dollars; the US current account deficit continues to improve; US market rates are rising on a relative basis; and global aggregate demand is still tepid at best; and industrial commodity prices continue to fade).
This Swiss event likely adds more deflationary pressure across Europe (not doubt inside Switzerland); it signals the end of a major buying prop for the euro (some referred to the SNB as the “buyer of last resort” for the euro). In short the Swiss decision is likely bad for global growth across the board. And we know emerging markets are highly levered to global growth. Thus, emerging markets are under pressure on all fronts.
Is it déjà vu all over again, i.e. another emerging market contagion that leaks into major markets? Who might be the next Long Term Capital Management (the firm that contained all those market wizards and noble economists that due to its massive exposure almost brought down the global financial system)? [If any grey hairs, like me are out there reading this, you may have remembered the event. I remember this aspect: With all LTCM’s models and analysis and considerable brain power, they never considered that bids for bonds would just disappear from their trading screens [that was a Black Swan event]. Well, they did. Liquidity disappeared just as it did when the SNB lifted the peg. To add an addendum to LTCM: 1) some of that disappearing liquidity for bonds was a bit of payback from the bigger players on the Street; and 2) lots of the stuff LTCM owned with pure speculations of the unmolded variety according to what I gleaned at the time. Not to worry, I am sure JP Morgan and Goldman Sachs would never be so exposed. J
Anyway, you might have noticed the Chinese stock market, measured by the Shanghai Composite, fell a whopping 7.7% today? Is this something connected? Here is what I shared in a note to clients this morning:
The Chinese stock market took a big hit today….ending down 7.7% on the Shanghai Composite on margin crackdown by Chinese authorities:
Reuters: Credit crackdown exposes flimsiness of China rally
Mainland stocks dropped 5 pct after regulators temporarily banned three brokers from opening new margin-trading accounts. The controls may cool rather than kill Chinese investors’ new enthusiasm for shares. But it’s a reminder how much the market mania depends on borrowed money.
As I said before, I think a lot of hot money locally is coming out of real estate looking for (or found) a home; stocks are the only game in town. The market looks like a bubble in the making or made given the tightening profit margins and massive overcapacity facing many of China’s companies operating in key sectors.
Housing prices continue to decline in China…from Reuters:
China's new home prices fell significantly in December for a fourth straight month even as year-end sales volumes surged - a somber omen for fourth-quarter 2014 economic growth data due out later in the week.
Sunday's gloomy National Burea of Statistics' data foreshadowed weak economic figures set for Tuesday, with expansion expected to slow to 7.2 percent, the weakest since the depths of the global financial crisis.
Falling property prices are likely to keep pressure on policymakers to head off a sharper slowdown this year.
The expected slowdown in growth of the world's second-largest economy, from 7.3 percent in the July-September quarter, means the full-year figure would undershoot the government's 7.5 percent target and mark the weakest expansion in 24 years.
I would add: Be careful out there because these things are all connected.
President, Black Swan Capital