Sunday, 18 January 2015

If everyone is expecting QE, what next?

20:40 Posted by The Thalesians (@thalesians) No comments

The size of the recent move in EUR/CHF after the removal of the floor, was clearly of a magnitude much larger than the market has observed recently. We can of course debate whether this was the largest daily move on record. However, whilst the timing of the removal of the floor was a surprise, the fact that the floor was actually removed, is not surprising. I have been working in currency markets for around a decade. Admittedly, this hardly qualifies as a long time. However, despite it being a relatively short time, I can recall quite a few occasions when currencies have experienced similar implosion type moves, albeit at a slower rate of the top of my head, without even a recourse to a Bloomberg plot. There is of course the recent move in RUB, as well as numerous other examples, in particular over the Lehman period. Going further back, other examples include the collapse of SEK and GBP in 1992 (of course, in the instance of CHF, SNB were trying to prevent their currency from strengthening, as opposed to weakening in the examples I have given).

So why did the SNB feel it necessary to go now? Was it the likely advent of ECB QE, which the market is now expecting at the next ECB meeting. Perhaps it was a political decision? There are many theories, but perhaps what is important now, is not so much the past, but will happen in the coming days at the ECB's next meeting on January 22nd.

The size floated around in market circles for the size of a possible ECB QE programme seems to be around 500bn EUR (see FT: Why the ECB should not water down a QE programme 18 Jan 2015). From a currency point of view, should EUR/USD fall if full blown QE is applied? We could argue that if the size of QE delivered is in line with market expectations, potentially not (indeed I was debating this point with @ericbeebo on Twitter earlier today). Furthermore, it has not always been the case that QE elsewhere has been accompanied by currency weakness.

The market has been selling EUR/USD on the story of Fed hikes and easing from ECB, given the mismatch in growth between the Eurozone and US. We haven't yet seen Fed hikes, although we have seen an exit from QE by the Fed. On the other side the ECB has eased policy, although, has not as yet pulled the trigger on full blown QE. Both short EUR/USD and long USD/JPY have been consensus trades. Currency traders have been rewarded for listening to central banks in these cases. But as the SNB has showed, listening to central banks is not always the most profitable trade.

The question traders face is when will they take profit on these trades? If the policy uncertainty becomes to great, the knee jerk reaction is to close your position or at least reduce it. Furthermore, if the ECB fails to deliver something "surprising", it could be an excuse to take profit, in particular given the extent of short positioning in EUR/USD (at least looking at CFTC data).

Traders are rewarded not for predicting the future, but for an ability to take the right amount of risk at the right time. Predicting the direction of the market, but having an inability to correctly size your trades, is never going to endear you to your investors. The action of the SNB and the pain it caused across the market will be a reminder to anyone who forgot, that traders are first and foremost in the business of managing risk.

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