I keep hearing those in the media talking of the SNB’s “peg”. I have to say it is NOT a peg….it’s a floor/ceiling/cap. There’s a difference. A peg is like what the CNY is to the USD with China forbidding it to move outside a very tight range either way. So it is indeed “pegged”. But with EUR/CHF, it is free to move as high as it wants above 1.20. There is no peg stating that it must trade within a narrow band around 1.20. It simply cannot go below 1.20 without intervention. Hence, the “floor” on CHF strength versus the EUR.
Would you agree with this? I know it’s a minor thing, but something I have thought about.
You are correct.
The peg is more of a fixed exchange rate, where the central bank does not want the currency to move at all away from the peg up or down. I believe they had fixed exchange rates in the Bretton Woods system before 1971. So they had fixed exchange rates, and every so often, the international bankers and finance ministers would get together and see if the fixed exchange rate tied to gold needed to be moved up or down. And occasionally they would move the fixed exchange rate up or down. After Nixon took the U.S. off the Gold standard in 1971, then that was the birth of the foreign exchange market.
Currencies became free floating susceptible to all the normal things such as news, speculation, macro, profit taking, short covering, commercial flows, etc. Of course back in the 1970’s the governments and central banks would try to intervene in the free floating system using rhetoric, policies, or actual intervention to influence the exchange rate just as they still do today from time to time.
That is why there wasn’t any currency trading prior to the 1970’s. There was no point in trading currencies because they had fixed exchange rates. If there is no volatility, you don’t make much money. That is why most of the money in speculation prior to 1970, occurred in the equity markets (via going long stocks that you thought were going up, or going short stocks you thought were going down), and via some commodity exchanges and futures contracts. I believe some of the Market Wizards traded futures contracts back in the 1960’s. But the futures contracts really got going in the 1970’s with the introduction of the currency futures contracts on the exchanges as well as more commodities such as gold, agricultural commodities, etc. So that opened up a new market. Traders could place trades in the equity markets, but also in the futures contracts for commodities and currencies, and also the spot forex market also existed in parallel and there used to be arbitrage between the spot fx and the futures contracts as was talked about in the first Market Wizards book.
Then in the 1980’s they introduced the financial futures contracts, such as the S&P and bonds, etc, and that created a whole lot more buzz and activity. So now you had a whole bunch of speculators and money managers start to trade the S&P and bonds such as George Soros, Michael Steinhardt, Paul Tudor Jones, and other people you read about in the Market Wizards books.
That is why Livermore back in the days didn’t trade currencies. They had fixed exchange rates and it was tied to gold, so he couldn’t trade them. He just had to focus on the equity long/short, and on some commodity exchanges like cotton that existed back then. Although, in my opinion, he made the most of his fortune via equity long and short trading and his macro analysis. When you read about him putting out a short line spread across a dozen stocks, that is macro analysis! He thinks the whole market is going down due to his macro analysis and betting on a scenario and expectation re alignment and spreading out his short line among a dozen stocks.
Then after the pegged or fixed exchange rate, there is the pegged float or “band.” Where the currency pair is allowed to fluctuate within a small band. If the authorities want to widen or lessen the band they can do that. This can cause problems if the macro forces are big enough to smash through the band, like what happened in 1992 when Soros broke the Bank of England and other currencies smashed through their trading bands.
Then after the bands, they have the floating exchange rates that we have today and that I described above.
So, yes, the 1.20 is not really a peg. It is more of a floor. It is the 1.20 floor. The SNB does not want the market to trade below that level. Some people refer to it as the 1.20 peg because for a very long time the macro forces were strong enough to keep a lid on the market and keep the market close to the 1.20 level. So the market was sandwiched between the big macro sellers capping the market and the SNB bids at 1.20, so some people called it a peg.
But as you said, the SNB would love to see the EUR/CHF move higher. It is free to move as high as it wants according to the news/sentiment/fundamental/macro players as they interpret the EUR data, CHF data, and rhetoric and policies out of the SNB.
The EUR/CHF could move below 1.20 with intervention if the SNB lowers the peg. But they would be stupid to do that as it would result in instant losses of tens of billions, and give the macro traders renewed ammunition to hammer away on the short side if they think the SNB is going to lower the peg more.
The EUR/CHF could move below 1.20 even if the SNB does not lower the peg. If the macro forces are strong enough to break through the bids from the SNB at 1.20, then they can push the market lower. But the macro forces are not strong enough, and to do that would require ungodly amounts of money. It would require hundreds of billions, and no one is crazy to go up against the SNB who may be willing to buy hundreds of billions, with the potential to print more money if they wanted to, especially since there is still deflation in Switzerland. No macro fund is crazy to short EUR/CHF at 1.20 and go toe to toe with the SNB because it is a bad trade. There are much easier trades to find.
Soros breaking the Bank of England was a completely different story. The BoE was not crazy enough to buy up hundreds of billions of GBP. They only were willing to buy up around $10-40 billion worth of sterling. And if the macro is strong enough, they can easily overwhelm $10-40 billion of central bank purchases over a period of a few weeks or month or two. The UK economic situation called for the pound to be devalued. The high value of GBP, and high interest rates were causing pain to the UK economy, so it was natural for the GBP to want to depreciate in value. So the BoE buying up GBP was a fools play because it wasn’t helping the UK economy at all. The Switzerland story is different. The SNB believed the high Swiss franc was causing a lot of pain to the Swiss economy and causing too much deflation. So it was natural for them and in the Switzerland’s interest to set the 1.20 floor. The BoE buying up billions of GBP in 1992 was definitely not in the UK’s interest.