Why the Forex Market Collapsed and What You Need to Know About it

The Swiss National Bank (SNB) statement on Thursday 15th of January sent a massive shock through the financial system. The SNB’s surprise decision to give up its currency peg of 1.20 with the Euro prompted dramatic price movements of epic proportion in the Forex market. The prominent movements could be seen on any of the Swiss Franc pairs.

Today’s post will discuss the event in details and analyze it from various angles.

SWISS DECISION: WHY?

The SNB abandoned its 3-year policy to protect the Swiss economy (via the peg) by arguing that the “exceptional and temporary” measurement was “no longer justified”. The protection was introduced back in September 2011 as an attempt to curve the demand for Swiss Franc, which was becoming increasingly popular due to the financial crises intensifying in the EU and due to its status as a traditional safe haven for investors.

The main reason for the decision was simple: keeping THE peg had become too costly for the SNB. The Swiss bank was buying tons of Euro’s to keep the Euro afloat against the Swissy. The cost for the central bank eventually outweighed the advantages.

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ECB AND QE?

Even more importantly, the costs (of the Swiss peg to the Euro) were close to rising exponentially next week if the European Central Bank (ECB) decides to introduce Quantitative Easing (QE). With the ECB having a negative interest rate, the monetary expansion could grow with rapid dimensions.

The SNB did not want to balloon its own balance sheet with even more Euro’s in face of the ECB’s decision next week on Wednesday (22nd January). The SNB did NOT want to run the risk of adding more and more Euros, which are becoming less and less valuable.

The fact that the SNB removed its EURCHF peg very close to the ECB’s decision moment greatly increases the chances that the ECB will introduce its own QE program.

CAN NEGATIVE RATES HELP?

In an attempt to curb demand for its Francs, the SNB decided to decrease interest rates even further from -0.25% to -0.75%. Negative interest rates make it less attractive to hold Swiss Francs as the buyer is punished (needs to pay). Whether the negative deposit rates helps mitigate the appeal of storing funds in the safety of the Swissy remains to be seen.

The SNB president Jordan considers the Swiss Franc to be overvalued and “assumes that this situation will correct itself”. However the ensuing global uncertainty (potential QE in EU, economic problems in EU, oil price slump, (geo)political risks) could persuade investors to park their money in Swiss Francs despite its negative rates.

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NEW SWISS INTERVENTION?

The SNB’s intervention in the Forex market to peg the EURCHF to 1.20 had created a distortion and imbalance for the past 3 years. Thursday’s release of the peg and its aftermath shows how rough those forces can be.

As traders we cannot rule out the fact that newly announced or hidden interventions by the SNB could take place – especially in the case when the situation does not correct itself as SNB president Jordan expects or when the global insecurity pushes investors back to the Franc.

The intervention this time around will probably not occur in the EURCHF currency pair, but perhaps in the USDCHF as the SNB attempts to regulate the value of the Swiss Franc by buying (better performing) U.S. Dollars rather than (value losing) Euros. Whether this will happen or not remains to be seen but the SNB has already intervened twice this decade, so a third time might not be strange.

Traders are warned.

What do you think are the chances of any intervention?

Thanks for sharing and Happy Hunting!

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Winners Edge Trading was founded in 2009 and is working to create the most current and useful Forex information and training available on the internet.

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