On the fourth anniversary of the Swiss National Bank’s (SNB) removal of the Swiss Franc (CHF) floor, the JPMorgan Chase Institute has released a new study exploring the trading behaviour of hedge funds during the SNB’s Minimum Exchange Rate policy period.
The SNB’s surprise announcement to remove the EUR/CHF floor and the subsequent exchange rate volatility serves as a case study of how central bank communication choices can impact financial market volatility.
The decision by the SNB to announce the removal of the Minimum Exchange Rate policy as a surprise in the period between regularly scheduled meetings likely did not allow investors to prepare in advance for this outcome, and could have contributed to the substantial buying of CHF and the 25 per cent decline in EUR/CHF in the 24 minutes after the announcement.
The report’s findings show that in instances when market stability is important, announcing policy outcomes at odds with market expectations at a regularly scheduled meeting may lead to less market volatility. When policymakers want markets to reprice rapidly and are less concerned with market volatility, releasing unexpected policy outcomes as a surprise announcement may be more effective.
The report, ‘Does the Timing of Central Bank Announcements Matter: Trade-Level Data on Hedge Fund Behavior Before Swiss National Bank Meetings’, builds on the JPMorgan Chase Institute’s first financial markets report, ‘FX Markets Move on Surprise News: Institutional Investor Trading Behavior around Brexit, the US Election, and the Swiss Franc Floor’, which first looked at hedge fund trading just after the SNB removed the EUR/CHF floor.
“Greater understanding of the ways in which institutional investors prepare for planned announcements and react to surprise announcements is a critically important tool for central banks as they consider changes in monetary policy,” says Diana Farrell, President and CEO, JPMorgan Chase Institute. “Our analysis of hedge fund behaviour in the SNB Minimum Exchange Rate policy period provides a case study for how central banks can choose between planned or unanticipated announcement timing to achieve their policy goals in a manner that minimises unintended market volatility or by surprising investors with market-moving news.”
JPMorgan Chase Institute data and analysis show that when the EUR/CHF exchange rate approached the 1.20 floor, hedge funds bought EUR and sold CHF in the anticipation that the exchange rate would rise. As long as the SNB was committed to maintaining the EUR/CHF floor, the potential loss for this long EUR/CHF trading strategy was limited. Hedge funds’ confidence in the persistence of the SNB’s Minimum Exchange Rate policy appears to have peaked in the 4 weeks before the policy was removed.
While betting on the long EUR/CHF strategy, hedge funds sold EUR/CHF just before regularly scheduled SNB meetings to reduce their potential losses should the Minimum Exchange Rate policy be removed at the meeting.
The SNB announced the removal of the EUR/CHF floor in a surprise press release rather than as part of a regularly scheduled quarterly policy announcement, likely contributing to the substantial buying of CHF in the three minutes immediately following the announcement and the 25 per cent decline in the EUR/CHF exchange rate in the 24 minutes after the announcement.
Had the SNB instead removed the EUR/CHF floor at a regularly scheduled quarterly policy announcement rather than as a surprise announcement in between meetings, hedge fund long positions in EUR/CHF may have been smaller, leading to less buying of CHF and therefore less volatility in EUR/CHF just after the announcement.
The report leverages a data asset of 395 million de-identified transactions executed by over 44,000 institutional investors. The research measures hedge fund net flows in EUR/CHF spot and forward transactions during the SNB’s Minimum Exchange Rate policy period.
