As global markets dig out from under the Swiss National Bank’s policy avalanche, it’s time to exhale and take stock of market volatility and the obvious long reach of the $5.3 trillion-per day foreign exchange market.
Quick Review: The Swiss franc rocketed beyond parity with the euro on Thursday after the Swiss central bank stunned markets by scrapping its long-standing cap on the strength of its currency. Most saw this as a pre-emptive move ahead of anticipated looser monetary policy in the European Union later this month (now, there are a couple of articles floating out there questioning why this even makes sense, so you may want to dig those up). SNB aimed to prevent the franc climbing too high, acquiring billions of euros in an effort to stop the common currency dropping below 1.20 to the franc. Without the cap, the franc surged more than 20%. Bank intervention eventually stymied that jump but not before forex pairs across the slate experienced large moves (check out this beautiful U.S. dollar-to-Swiss chart, below). According to the financial press, the Swiss National Bank has intervened in markets since September 2011—more aggressively in the weeks leading right up to (I’m not kidding) the decision yesterday to stop interfering.
In the aftermath, these actions hit a handful of foreign-exchange trading firms (some publicly traded like FXCM) whose customers were caught wrong-footed to a degree that threatened the capital health of the platforms themselves. But beyond pulling the rug out from the currency market, this week’s Black Swan is a reminder that Europe’s economic struggles are likely to continue to factor in U.S. stock trading even as signs of a largely healthy growth stretch for the U.S. continue. Notably, U.S. stocks snapped back Friday in part because consumer confidence data surprised to the upside—can’t ignore the domestic picture, either.
Teaching Moment. Forex trading is huge, so huge in fact that it takes place off-exchange and 24/5.5. Behind the flows are wonky factors like country balance sheets, interest-rate differential, and so on. But when it smacks straight up against the stock market, those technical factors may matter little. Now, don’t underestimate the shock value in this week’s currency and stock market moves. Thursday’s action came out of left field; it had velocity, it had breadth. After all, we are talking “Black Swan,” the hard-to-identify phenomena that can mess with your due diligence, earnings vigilance, and many other fundamental check-lists you may love. And we are talking about action from a big-muscle central bank while most U.S. investors snored away. Think of it this way: If the S&P 500 (SPX) futures had shed 20% before your feet hit the bedroom floor, it would be a BIG deal, right? The franc jumped 25% against the U.S. dollar at one point. That compares to about a 4300-point move in the Dow Jones Industrial Average. When traders woke up the world over, their knee-jerk reaction was to sell first and ask questions later. The painful part for stock bulls was this Black Swan floated by as Wall Street had already logged four straight down days.
Broker Health. These events are always gut-check time for our industry and the clients we serve—even those whose most direct forex market dealing (they think) is pulling out a grubby $20 in the deli line. Headlines about capital requirements or rogue trades are scary. They’re also often reserved to a unique set of circumstances. But what traders and investors can do is ask the right questions of themselves and the industry: What risk controls are in place? What counterparties do my broker/trading platform engage with? What happens to MY money not used in my forex trading positions? For instance, is it covered by a regulator such as Securities Investor Protection Corporation (SIPC)?
Here’s the reality: there’s a massive amount of money circling the globe every day. That’s a beautiful thing. Another beautiful thing? Brushing up on risk and readying for the market’s next ugly duckling.