The pressure is increasing in the currency markets as the USD approaches new lows. The central banks with strong currencies, such as Australia, Canada and Europe, will have to decide whether or not to adopt the policy of the SNB and intervene to weaken the EURO.
The SNB has intervened for the past 6 months and has temporarily blocked the Swiss Franc from appreciating. The cost of doing so is, however, higher than most people appreciate. There are more and more traders, who are shorting the CHF and rely on the SNB to intervene in the market. The SNB interventions have the effect of subsidizing these speculators and are becoming increasingly costly.
If the SNB does not want to get hit by a backlash of its intervention strategy, then it will have to change its intervention strategy and shift from targeting a particular price level to defending a volatility range. This implies intervening intraday and capping the price extremes by selling CHF whenever the price appreciates short-term and selling as soon as the market rebounds. For this strategy to be effective, the SNB needs to be ready to intervene around the clock, not in large amounts but in smaller ones to cap the short-term overshoots.
A dynamic intervention strategy targeting a level of volatility cannot be hijacked by traders to speculate on specific price levels. The SNB will not stop the CHF from appreciating but will prevent the big overshoot, which occurs through price spikes that trigger cascades of margin calls. The smoothing of markets will slow down the process of appreciation of the CHF and will speed up the process, where the CHF finds its top and starts to revert.
The currency markets are in a precarious state: on the one hand the speculative flows have declined dramatically and on the other there is a large disequilibrium on a macroeconomic level necessitating big fundamental capital flows. In the absence of a strong liquidity cushion these big capital flows will lead to big price moves that will be further amplified by cascades of margin calls of speculative traders. Static interventions as conducted by the SNB can only provide momentary respite at the cost of a large price move later on. A viable strategy is, however, to conduct a dynamic intervention strategy to keep short-term volatility at bay and balance supply and demand.
Author: Richard B. Olsen, Founder and CEO of Olsen Ltd
I have been doing trades for nearly 7 years up til now and I am always watching for practical websites and writings. This one definitely hits a note with me and I’m thinking about republishing it on my own blog. Do you mind if I do?
Yes, thank you. Yes, you can republish the blog.