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    The document summarizes the situation facing the Swiss National Bank (SNB) as it defends the peg of the Swiss Franc to the Euro at a rate of 1.20. The SNB will report its foreign currency reserves for September, which are expected to have increased substantially as the SNB had to purchase large amounts of Euros to maintain the peg. If the peg falls, it could bankrupt the SNB and cost Swiss taxpayers billions. Speculators are circling, waiting for an opportunity to attack the peg. The more Euros the SNB needs to purchase to defend the peg, the more it effectively prints Swiss Francs, risking a loss of the currency's value over the long run.

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    High Noon at the Swiss National Bank

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    The document summarizes the situation facing the Swiss National Bank (SNB) as it defends the peg of the Swiss Franc to the Euro at a rate of 1.20. The SNB will report its foreign currency reserves for September, which are expected to have increased substantially as the SNB had to purchase large amounts of Euros to maintain the peg. If the peg falls, it could bankrupt the SNB and cost Swiss taxpayers billions. Speculators are circling, waiting for an opportunity to attack the peg. The more Euros the SNB needs to purchase to defend the peg, the more it effectively prints Swiss Francs, risking a loss of the currency's value over the long run.

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    140 views4 pages

    High Noon at The Swiss National Bank

    Uploaded by

    smcjg
    The document summarizes the situation facing the Swiss National Bank (SNB) as it defends the peg of the Swiss Franc to the Euro at a rate of 1.20. The SNB will report its foreign currency reserves for September, which are expected to have increased substantially as the SNB had to purchase large amounts of Euros to maintain the peg. If the peg falls, it could bankrupt the SNB and cost Swiss taxpayers billions. Speculators are circling, waiting for an opportunity to attack the peg. The more Euros the SNB needs to purchase to defend the peg, the more it effectively prints Swiss Francs, risking a loss of the currency's value over the long run.

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    HighNoonAtTheSwissNationalBank

    ByAlexanderGloyofLighthouseInvestmentManagement

    Tomorrow,Thursday(October6th),theSwissNationalBankwillreportitsforeigncurrencyreservesfor Septemberat9amlocal(3amEST). WewillknowthenhowmuchEuroshadtobegobbledupinordertodefendthepeg.Increasingtickvolume inrecentdayslookssuspiciouswhywouldtherebemorevolumethanondayswheretheSwissFranc reachedparity?OrthedaytheSNBintroducedthepeg?

    YoucanttellmethatwerecentlyhadtwiceasmuchvolumeasonSeptember6,whenthishappened:

    TheSNBvowedtopurchaseunlimitedquantitiesofEurostodefendthe1.20barrier.Howcredibleisthat? Letslookatsomedata:

    Hereiswhatisgoingtohappen: SNBsbalancesheetwillexplodeastheyhavetobuybillionsofEuros(aquestionableasset,tosay theleast). ForeveryEurobought,1.20CHFarebeingreleasedintocirculation.CHFmonetarybaseexplodes, too. Ifthepegfalls,theensuingcurrencylossesmightbankrupttheSNBandcostingtheSwisstaxpayer billionsofCHF(theyalreadylost29bnoverthelast18monthsor6%ofGDP). Accordingtorumors,theSNBissosureabouttheirabilitytodefendthepegtheyweresellingEuro puts.ThosewouldexpireiftheEurodidnotfallbelow1.20,allowingtheSNBtokeeptheoption premium.Isthisanillfatedattempttomakebacksomeofthelossesincurredearlier? Inordertodiscouragespeculators,theSNBtriedfloatingrumorstheymightincreasethepegto1.25 orto1.30. AstheEuroweakenstowardstheDollar,theSwissFranchastodecline,too(inordernotto strengthentowardstheEuro).ThismakestheSwissFranccheapvisavistheDollar. AGreekdefault(orotherEuroworries)mightmaketheEuroevenweaker,makingithardertokeep itstabletowardstheSwissFranc.

    PleaselookatthestatementbytheECBimmediatelyfollowingtheSNBannouncement:

    Itisprettyfranc(foracentralbankstatementanyway). TranslatedintoplainEnglishthismeans:Wehavenothingtodowiththisdecision,wewillnot supportitandwewishtheSNBgoodluckshouldthepegcomeunderpressure. This,fromasistercentralbank,isaslittlesupportasyoucanget. TheECBisprobablynottoohappyanothercentralbankistryingtokeeptheEurostrong.

    Ofcourse,thereisonedifferencewiththePoundSterlingbeingkickedoutoftheERM(EuropeanExchange RateMechanism)in1992:theBankofEngland(BoE),tryingtodefenditsweakcurrency,hadtopurchase Poundsandsellothercurrencies(Deutschmarksetc)fromitsreserves.WhentheyranoutofDeutschmarkto sell,itwasgameover. InthecaseoftheSwissFranc,thecurrencyistoostrong,sotheSNBsellsitsowncurrency,and purchasinganothercurrency(EUR). Intheory,thiscancontinueadinfinitum.However,eachtimetheSNBsellsSwissFrancs,itincreases themonetarybase,alsoknownasprintingmoney. However,printingtoomuchmoneywilldestroythecurrencybymakingitworthless. HowmuchdidtheSNBprintsofar?LookingatFX(foreigncurrency)reserves(theoppositeentry intheSNBsbalancesheet)theyincreasedfromCHF112bn(end2010)to253bn(endAugust2011) orfrom23%to50%ofGDP .ThisisBEFOREinstallingthepeg(belowchartasofendofQ2;SNB publishedonlyquarterly):

    ItispossibletheSNBdidnthavetopurchasetoomanyEurosyet,asthemarketsawnopointinimmediately attackingthepeg.Themovefrom1.12to1.20wasveryquick(minutes)andshortcovering(fromthe perspectiveofaEuroshortseller)probablydrovemostofit.HastheSNBhaskeptitspowderdry? ButasGreecedefaultsandpossiblyquitstheEuro,arunontheSwissFrancmightreturn.Andwhy notthankstotheSNByoucangettheSwissFrancmuchcheapernowabargain. HowmanyEuroswillittakebeforetheSNBhastogiveup?Dotheyhaveaninternallimit?Idont thinksotheyprobablybelievetheycanhandlethis.100%ofGDP?200%? 200%monetarybasetoGDPwouldmean1trillionCHFor750bnhigherthanendofAugust.At1.20 thatwouldbeequaltoEUR625bn. Currencyspeculatorsworkwithhugeleverage;100timesisnotunusual(anybodycanopenan accountatoneofthenumerousonlinecurrencytradingshopsandspeculatewith30xleverage).In ordertosellEUR625bnyouwouldneedonly6.25bninequity.Thehedgefundsareprobably circlingtheSNBlikesharksalready.Hencetheregularleakofrumorsofanincreaseofthepegin ordertoburnspeculators.

    Optionswillalsobepartoftheattack(ifyouloaduponfaroutofthemoneyoptions,andstart movingthepriceinyourdirection,deltahedgingbymarketmakersandcounterpartieswillalmost dotherestforyou). Currently,impliedvolatilityforCHFoptionsisstillabithigh.Speculatorsmightwaitforittocome downfurtherpayinglesstimevaluecanincreasetheleveragesignificantlyforoutofthemoney options.

    Itisunfortunatetoseeapeoplesmoneybeingwastedrecklesslyandpredictably.Intheend,theonlysolution toavoidmarkinghugecurrencylossestomarketwouldbetojointheEuro.Maybethathasbeentheplanall alongtoignorethepeopleswillandabolishtheSwissFrancthroughthebackdoor.Voterscouldbe confrontedwiththechoiceofeitheracceptingtheEurooreatingbillionsoflossesastheSNBwillhavetobe recapitalized.

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