Intervention risk in the forex market

The past few months have been a volatile time for the markets, and forex, usually the most liquid of them all, has been no exception.

Considering the US debt ceiling announcement, S&Ps downgrading US debt from AAA to AA+ and the US and Europe’s respective debt crises, this isn’t surprising.

However, another element has been altering market dynamics since August – currency intervention.

Traditionally seen as safe havens, both the Swiss Franc and the Japanese Yen have been hit by government intervention.

After hitting record highs against the euro and the USD, the Swiss National Bank (SNB) started intervening in the CHF from August 3, 2011. Taking the market by surprise, it first lowered interest rates to zero to dissuade foreign investors from buying their currency, the logic being that investors would prefer higher-yielding assets.

However, days later when the markets worried about the European banking sector and French bond spreads with Germany reached multi-year highs, the CHF was only 70pips from parity with the euro.

Then, on September 6th, the SNB is pegged the currency to the euro at a minimum exchange rate of CHF1.20, and have threatened to enforce this rate with direct intervention in the forex market.

Likewise, when the USD/JPY hit record lows the Bank of Japan followed suit, intervening on August 4 by selling off its currency, resulting in the USD rising strongly in response. More recently, Japan’s finance minister Yoshihiko Noda asserted that the government would step in to temper the forex market if the yen continued its climb.

This means that, when trading forex, traders need to price the chance of central bank intervention risk into their trading – central banks usually don’t give warning and, after they intervene, the effect of their actions can be unpredictable. Rather than rushing into the CHF and JPY when risk is running high, investors need to acknowledge that the SNB and BoJ are now willing to use their power to tear their currencies from the safe haven title. If they succeed, this will have major ramifications on the forex market as there are no obvious alternatives.

The sovereign debt crisis has ruled out Europe, the UK is still suffering from the aftermath of the financial crisis and commodity currencies, like the AUD, NZD and CAD, are too dependent on global growth and commodity prices. And, emerging currencies are often tightly controlled, like the CNY and SGD.

This is likely to change the traditional relationships in the forex market, as an absence of safe havens will simply boost the attractiveness of gold and treasuries in volatile markets. That being said, in the forex market something is always going up, which means that, without traditional safe havens, markets will instead focus on relative value.