They say extraordinary times call for extraordinary measures. The past week has shown us what 2015 may hold for traders, particularly pointing to the inherent risk the small group of retail traders takes on a daily basis and just how a black swan event can take even the most seasoned professional by surprise.
Even the word ‘surprise’ seems to be inadequate for the massive jolt to the markets provided by the SNB. The aftermath of Thursdays decision caused confusion as experienced business news desks struggled to work out the consequences.
And here is why…no-one knows. We are in a world of extended QE programs, global relationships that wax and wane, increasing threats of black swan events and uncertainty born of combining such a world with terror threats and international unrest.
Markets have been skewed from their natural boom /bust rhythm by central bank manipulation. It is comforting to think we can be protected from the ‘bust’ phase but manipulation comes at a price and one of them is a lessened ability to predict, without which trading becomes gambling.
In this extended report, I will look at the events in Switzerland and economic data as usual but also how we can control our risk to an extent now demanded by circumstance. After all we are not here just to protect our money but to make it. This week saw millions of accounts wiped out, margin calls and established brokers, including Alpari go into liquidation. Many others have incurred huge debts.
Forex Fall-out: The Swiss Decision
No doubt you have read some of the endless articles and blogs on why the SNB took the decision to end the euro cap and furthermore why no-one knew.
What is interesting is that the massive buying of euros increased the Swiss balance sheet. At the same time it also synthetically propped up the price of the Euro and speculate as we may we will never know if the ECB knew and were approving of the decision to devalue the currency further.
When the QE decision is announced next week by the ECB at their meeting on Thursday, we will see if the launch goes ahead. If it does the Swiss would have had to stump up more funds for the inevitable fall in the Euro. The timing is telling. Some say there is no such thing as a coincidence.
As a personal insight, I lived in Switzerland for 10 years. The state keeps its cards close to its chest and it is a very private society. I cannot accept that the Swiss are throwing caution to the wind. They are simply taking back control of their own recessionary risk and will, I believe, have a tight and precise plan for dealing with it, beginning with the negative deposit rate which they announced simultaneously. More measures should be expected.
This is a quote from the SNB statement which clearly shows there intention to take control;
“The SNB will continue to take account of the exchange rate situation in formulating its monetary policy in future. If necessary, it will therefore remain active in the foreign exchange market to influence monetary conditions”
Can we expect the kind of transparency that we have come to expect from the FOMC as to these intentions? I think not, it is not the Swiss way.
With the 10 year bond yield now falling into negative territory, it is possible for the further out bonds will eventually follow suit. The reality is that investors are prepared to pay to loan out money to the government to keep it safe for a 10 year period. And Switzerland are not alone, so does Germany France and Japan to name a few and of those who are still positive such as The UK and the US it is barely more than a nominal amount.
That does not give much optimism for the global economic outlook and in the light of current events, we should not be at all surprised.
The effect of the decision? The the Swissie gained 1627 pips against the USD,
3248 pips against the Euro but settled up a little at .9925.
A free fall back into market forces.
Where from Here
The ECB will make their announcement on Thursday. It will be another unpredictable week and if Mr.Draghi fails to step up to the plate and plays for more time then expect a backlash, especially in European stocks. The strong expectation of the market is that we will see sovereign purchase on a hefty scale but if there is one thing this past week has taught us, NEVER EVER make assumptions about the forex market.
The ECB’s anticipated objective is to inject enough liquidity to fire inflation to counter act deflationary pressure. With oil prices 50% less than the were 6 months ago, and funds to spend the outlook should be rosy for Euro stocks and some balance gradually return as the dollar edges higher and the euro edges lower and the Europeans can establish themselves competitively in the international marketplace. At least that is the plan and the hope and the way cycles work however long it takes.
This week the Euro hit an eleven year low against the dollar. However, the Euro-zone problems may not be solved by QE as fast as the US as it continues to wait the outcome of the Greek elections and the instability that causes. Furthermore it is not clear which sovereign bonds it will buy from its many nations and how thy will be balanced in terms of a the various interest rates. It is a complex web of economic and political balancing.
Euro CPI came in on target this week with a slight miss on core CPI. There was no other important data but the focus was as we know elsewhere and much more to do with policy than data. Traders have developed something of an immunity from disappointing EZ data and now the Swiss have pulled the ECB into an even finer focus.
News for the Greenback
Unlike the Euro, the USD is data driven and putting aside all the drama on Thursday, if that is possible, it wasn’t a great week for the greenback. The Jolts report, jobless claims and a favourite of the FOMC chairman exceeded the number expected early in the week, but retail sales missed (and the core number) slipping into negative territory. On Thursday unemployment numbers were worse than expected, as was CPI, core CPI and industrial production on Friday.
But there is always a mixed bag from the US and PPI was ok with core PPI exceeding the expectation, one manufacturing index missed and another exceeded. The week ended on an upbeat note with consumer sentiment solidly above the number. It was a busy week even without the Swiss imput.
As for policy, the FOMC member continue to issue statements and have become more dovish in the first weeks of the year. However there are members still looking to mid year for rate increases whilst others see circumstances justifying ‘accommodative’ policy for the rest of the year.
How Sentiment affects Forex
The black swan event of Thursday had a tangible effect in the equity and bond markets. In the US bond prices increased on Thursday but gave back some ground on Friday. The 10 yr note yield edged down. All the US equity markets suffered losses as a result of the SNB event gaining some ground back the following day. In Europe yields also edged down but equities moved up on the european bourses, in anticipation and as a direct interpretation of the Swiss decision that Draghi will indeed launch his QE program.
A flight to quality was evident in the US markets and Gold at last broke a weekly trend line and proved itself the safe haven that was once assumed making a significant move on Thursday and Friday.
The AUD/JPY, our sentiment measure, has dropped significantly over a nine week period with a further close down on the week and a volatile down day on Thursday. Here is the weekly chart;
The Vix also up this week closing at 20.85, having started the week at 18 and reaching toward 24. This is part of the weekly sentiment check especially after the week just experienced.
Major and unexpected events always rattle the market and another big meeting to watch for from the ECB will not do anything to calm nerves.
The USD is a safe haven in risk averse markets and despite the gigantic move down against the Swissie the USD index closed higher once again on the week, here shown on a weekly chart;
Risk control in the Forex market
As we have seen, brokers and retail traders suffered heavy losses this week. Some saw their accounts disappear, some are locked away as Alpari go into liquidation. Unprecented losses some think are due to over- leveraging and lack of risk-awareness among new and inexperienced retail traders. FXCM were loaned 300Million dollars to stay afloat. The losses have not all yet been uncovered but suffice it to say they are extensive and disturbing and embrace hedge funds and individuals alike.
The forex market carries inherent risks. The 101 rules should never be dispensed with, always use a stop, limit position size.
Of course a stop does not necessarily protect from loss, as when markets move viciously and unexpectedly the stop order may not be filled. There were even stories on Thursday of brokers freezing trading for spells when the movement was strong. Know your broker. Is it a dealing or non-dealing desk? Some brokers guarantee stops a lot do not. Know how much leverage you are trading with.
Do not trade without understanding the types of orders, market orders, limit orders, stop limits etc
So how can we avoid such a situation? Well simply put we cannot but of course such an event is extremely rare. We can take the lesson however that the unexpected does occur. Stops are ESSENTIAL even in a fast moving markets. Many traders still do not use them.
More importantly there are other investments that we can and should use to spread the forex risk including ETF’s to create our own ‘hedged ‘ portfolio. I will be posting again on this subject and where to find out more in the next few weeks.
In Conclusion
In a week where the world bank warned of impending global stagnation no one could guess the mayhem ahead. Swiss secrecy also had IMF Lagarde bemused and disturbed.
These are precarious times indeed. Fundamental awareness going forward just became even more essential to the retail trader who wants to attain any peace of mind however rare events like the one seen this week
Stay safe. Stay tuned.
Judith P Waker
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