Peter's Perspective
21st January 2015 by Peter Churchouse

Ouch! An Expensive Lesson.

Last Friday evening, before boarding my flight from a cold and polluted Beijing I called the office for the usual update. Yes, the ski trip to France and the weekend visit to Geneva were arranged. The hotel in Geneva looks great and is paid for. The train ticket from Geneva to Paris is booked and paid for. Excellent.

I arrived in Hong Kong airport some three hours later. I turned on my phone for a casual surf of Bloomberg news after we landed.

The Swiss National Bank’s (SNB) decision to abandon its currency cap was the headline item. The three yearlong policy of capping the value of the Swiss Franc to a value of 1.20 francs per euro had been dissolved with immediate effect.

As a result, at some point during the flight my hotel bill in Geneva went from about Euro 270 to costing me about Euro 375. Luckily the bill had been paid.

This was a genuine hand grenade rolled into global markets. There had been no inkling anywhere of such a move. Quite the opposite in fact…

On the Monday of last week, Jean-Pierre Danthine, the Vice-Chairman of the Swiss National Bank said,

“We took stock of the situation less than a month ago, we looked again at all the parameters and we are convinced that the minimum exchange rate must remain the cornerstone of our monetary policy.”

The chart below shows the intraday price move of the Swiss franc against the Euro that day. For a currency pair like this to move 30% in a little over 20 minutes is chilling… this isn’t some emerging market tin pot economy. This is the Swiss franc for goodness sake!

Swiss Francs per Euro on the day it was unpegged, January 16, 2015.

Since the global financial crisis the Swiss franc has been viewed as a reliable “safe haven” currency.

In December of 2007 one euro bought you nearly 1.7 francs. Today that euro only buys you around 1 franc (last week a euro bought you as little as 0.85 francs).

When people want to sell their euros and buy francs, the SNB has to buy the euros and print francs which means expanding the monetary base and holding more and more continually depreciating Euros.

I guess they decided they’d had enough. And with European QE likely to be announced tomorrow, this would only put more buying pressure on the franc as Draghi seeks to devalue the euro further.

Switzerland's Monetary Base in Billions of Swiss Francs from Oct 2007 to Jan 2015.

So when we look at an event like this, what are the key points to make?

Firstly, don’t trust central bankers!

“When it becomes serious, you have to lie.”

Jean-Claude Juncker, President of the European Commission

We’ve seen this time and again throughout history.

For policy changes of this magnitude, there are no gentle hints to the market… It’s just one day the policy is there, the next it isn’t… In this case, it’s reminds me Thailand’s policy commitment of defending the baht… right up to the day they decided they wouldn’t anymore.

Secondly, far too many individuals are over-leveraged and completely out of their depth when it comes to basic risk management.

Let me explain.

FXCM Inc. is a U.S. based brokerage specialising in FX for retail investors globally. Highly leveraged bets against the Swiss franc by its customers left the brokerage facing a shortfall of a quarter billion dollars.

Shares in the company fell by as much as 92 percent before trading was halted.

Ironically, in 2010 U.S. regulators wanted to mandate that individual investors place at least 10 cents of capital to back each dollar of exposure. As a result of lobbying by FXCM and other foreign exchange brokerages, investors only needed to post 2 cents of cash for each dollar wagered… a leverage ratio of up to 50 to 1.

Tell me, on what planet should retail punters or indeed anyone be using that kind of leverage? It’s ludicrous.

Drew Niv, FXCM’s CEO last year said “Currencies don’t move that much, so if you had no leverage, nobody would trade.

What a farcical statement.

These retail FX trading brokerages are often just used as a form of “respectable” gambling. I’ve seen friends and acquaintances do this kind of stuff in the past. Lessons are painful.

And people are BAD at it! SIXTY EIGHT PERCENT (68%) of FXCM retail accounts lost money last year.

You get far better odds (along with free drinks) at the roulette tables in Macau.

The second area of risk management concerns foreign currency mortgages. I’ve written about this before in my “Rules for Buying Real Estate: Lessons from the Trenches” (available to subscribers of The Churchouse Letter).

Foreign currency mortgages are when homeowners in a relatively higher interest rate country (say Hungary), borrow a lower interest rate currency (Swiss francs) to buy their home. They then have to repay interest and principal in Swiss francs.

People do it because interest repayment is reduced… but the risk you assume is colossal.

It’s insane for a whole host of reasons, but the main problem with this strategy is that in this case your earnings are in Hungarian forint, but you need to buy Swiss francs every month to repay your mortgage.

The forint is now down around 55% against the franc since 2010.

This means your mortgage repayments have ballooned AND you’re likely deep in negative equity (whereby the loan on your house in forint terms is larger than what you could get if you sold the house).

Financial advisors all over the world will try and sell you foreign exchange mortgages. I suggest you hang up the phone (politely or otherwise) when they call.

Thirdly, distorting the market and suppressing volatility inevitably means more volatility in the end.

I’m not going to get into this now because in this month’s edition of The Churchouse Letter our sights are set on Europe and a market distortion that we believe will ultimately bring the European market to its knees…. Long-time readers will know I’m no alarmist, but this makes this Swiss franc episode look like a teddy bears picnic by comparison.

And of course, we’ll be providing our top recommendations to profit and protect.

Good investing,


Peter Churchouse Peter Churchouse is a widely respected analyst and commentator on financial markets with well over 3 decades residing in Asia. He spent over 15 years as Asia Strategist and Head of Research for Morgan Stanley as well as running a hedge fund. He shares his knowledge, insight and investment recommendations through his subscription publication The Churchouse Letter, along with his free newsletter Peter’s Perspective.
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