Charts of the day, Swiss franc edition
As a general rule, it’s the risk-on trades which have a tendency to blow up in your face. If you borrow in a low-yielding safe currency and invest in a higher-yielding risky currency, you make money every day, but can lose it all — and then some — with one violent currency move, when the risky currency suddenly weakens.
Today, however, it’s the other way around. With one announcement, the Swiss National Bank sent the Swiss franc — a classic safe currency, which rallies in times of uncertainty — plunging. To give you an idea of just how insanely huge today’s currency move was, here it is in the context of the past 12 years or so:
What this chart shows is that even during the recent crises, the Swiss franc basically never rises or falls more than 2% in one day. Today, it moved more than 8% — that’s a 20 standard deviation move. If market movements were normally distributed (which, of course, they’re not), 20 standard deviation moves would never happen. You can be quite sure though, that the SNB move today caused a lot of pain to a lot of people. Remember what the Swiss franc volatility surface looked like a couple of weeks ago?
As I wrote back then, this chart shows a market very bullish on the Swiss franc and bearish on the euro — a market betting strongly against the SNB’s ability to weaken the Swiss currency. Well, that didn’t work out very well. But just check out what the same chart looks like today, post intervention:
The first thing to note here is that the crazy implied volatilities seen two weeks ago seem positively low by today’s standard. Check out the y-axis: it’s now going all the way up to 31.35, compared to a maximum of 26.975 last time we looked at this chart. And in general the entire surface has risen a lot over the past couple of weeks. If you want to bet on the Swiss franc today, in any direction, you’re going to have to pay a lot of money to do so.
But there’s still a huge amount of skew here, in exactly the same direction. Over the near term, it’s not as pronounced as it was — there are lots of people betting that the SNB might be able to weaken the Swiss franc over the next few weeks. But over the long term, the market is speaking clearly: everybody thinks the Swiss franc is going to strengthen and many fewer people think it’s going to weaken. The SNB might have won this battle, but it’s not going to win the war.
And this is a hugely important war for Switzerland. Michael McDonough puts the Swiss franc’s strengthening into the context of Switzerland’s domestic economic health:
The problem is that the international capital flocking to the safe haven of the Swiss alps really doesn’t care about Swiss exports. And if you look at Swiss exporters, even the top gainers, like Swatch, which rose 6% on the day, actually fell in euro terms. The broad Swiss stock market, up 3.9% today, didn’t even come close to making up for the currency losses imposed by the central bank on foreign investors.
The main winners today, I suspect, are just going to be black swan funds and anybody else making bets on extreme market moves. You don’t see 20-standard-deviation events very often, and when you do, there are always one or two people with out-of-the-money options who suddenly make a fortune. But over the long term, the markets are stronger than any central bank. The Swiss franc will test 1.20 again, and when it does, we’ll see in practice just how many euros the Swiss National Bank can stomach before it gets full.