What the SNB really taught people this week is what emerging markets people have known for decades, and actually, developed markets traders really should know too. You should never trade a peg in the direction that is being defended by a central bank. You should almost always fight the central bank.
Anybody who takes a cursory glance at history will know this: ERM 1992, Russia 1998, Brazil 2001, and yes, Russia H2 2014 (semi peg). The examples of peg breaks are numerous, and some recent. No excuses.
A "grid trading" strategy that was essentially recommending picking up pennies in front of a steamroller, was irresponsible at best. One should always look at the balance of payments of a country to see if it is in surplus or deficit, and trade the currency accordingly. Swiss was in massive surplus on the capital account. This guy was recommending selling swiss francs for a tiny, marginal carry trade in euros.
And if you don't know what balance of payments means, you really should figure it out before committing money to the FX market.
Finally, all the bull about liquidity. Of course there is no liquidity when a market revalues suddenly. This is the same in equities: if an unexpected announcement happens, the price revalues instantly and there is no liquidity in between. It is a discrete event. Econ 101.
I agree, but usually the pegs in the other direction are more dangerous.
When the government has too many Dollars (or Euros) they usually have time to find a soft solution and change the conversion rate slowly. It's always easy to burn money.
When the government has too few Dollar (or Euros) the amount of reserved money go down, they exchange the real money for valueless internal bonds, and one day they get up and they don't have any money left in the treasure and they are forced to make an abrupt correction.
Good point, and China has for years adopted this approach. Problem is, they are now long of a trillion dollars of US debt, and are as a result, at the mercy of their own debtor. I think the Swiss were wary of that scenario: becoming longer of European debt. If they had adopted a gradual approach, they would have been showing their spoof poker hand, days after having asserted that the peg wouldn't move. The market would have sold billions more euros to them which they didn't want.
Complete agreement. If the central bank is defending a rate, "defending" means spending money, and you want to be on the side that's getting the money. Simple. Russia has/had been pouring money into propping up the ruble, said money was received by FX traders with the correct positions. The worst outcome for central banks, which is frequently what comes to pass, is they spend a ludicrous amount of money defending their position and in the end they still lose.
Is there good data on how often they lose? Sure, I can think of plenty of examples of central banks being forced to give up their peg, but I can also think of plenty of examples where the traders betting against them lost out. You'd need to consider both if you really want to use historical data as a justification for trading. For example the EUR/DKK peg has been challenged on numerous occasions without success. China has also been fairly successful in dictating its exchange rates, with some currency movements but generally on its own timetable and very carefully controlled.
It's an interesting question. Googling briefly I didn't come across obvious studies. I guess it depends on how you do the accounting. A week ago the Swiss National Bank had foreign currency assets of about 520bn euros or 624bn Swiss Franks. It now has asset of about 520bn euros or 520bn Swiss Franks. Is that a loss of zero which it looks like if you do the accounts in euros or 104bn Swiss Francs if you do it in Swiss Francs?
Anybody who takes a cursory glance at history will know this: ERM 1992, Russia 1998, Brazil 2001, and yes, Russia H2 2014 (semi peg). The examples of peg breaks are numerous, and some recent. No excuses.
A "grid trading" strategy that was essentially recommending picking up pennies in front of a steamroller, was irresponsible at best. One should always look at the balance of payments of a country to see if it is in surplus or deficit, and trade the currency accordingly. Swiss was in massive surplus on the capital account. This guy was recommending selling swiss francs for a tiny, marginal carry trade in euros.
And if you don't know what balance of payments means, you really should figure it out before committing money to the FX market.
Finally, all the bull about liquidity. Of course there is no liquidity when a market revalues suddenly. This is the same in equities: if an unexpected announcement happens, the price revalues instantly and there is no liquidity in between. It is a discrete event. Econ 101.