Markets in Shock After Swiss Decide to Remove Currency Cap

Swiss Economy Minister Johann Schneider-Ammann (C) speaks to media in Bern January 15, 2015. The Swiss National Bank (SNB) shocked financial markets on Thursday by scrapping a three-year-old cap on the franc, sending the safe-haven currency soaring against the euro and stocks plunging amid fears for the export-reliant Swiss economy. Thomas Hodel/Reuters

NEW YORK/LONDON (Reuters) - Currency speculators, especially large global macro hedge funds with big short positions in the Swiss franc, are staring massive losses in the face after the Swiss National Bank shocked markets on Thursday by removing a three-year-old cap on the currency.

The move sent the safe-haven franc soaring against the euro and the U.S. dollar at a time when more than $3.5 billion was positioned in favor of franc weakness, the largest such position in more than a year and a half.

Only days ago, the SNB termed the 1.20 francs per euro cap the cornerstone of its monetary policy.

The damage from the Swiss franc's sharp moves comes as a blow for macro hedge fund managers nursing wounds from nearly four years of mediocre performance.

"You have these massive policies which forced all investors to invest with the policy and then they remove the policy and everyone is left high and dry," said Chris Morrison, strategist for the $550 million Omni Macro Fund.

Data from the Commodity Futures Trading Commission released on Friday showed net short positions of 24,171 contracts on the Swiss franc, the largest since June 2013. Adding in 662 short option contracts gives a combined position of 24,833 contracts or $3.5 billion at the current rate of around 0.90 franc to the dollar.

Global macro hedge funds that use fundamental analysis to bet on the financial markets and representing $288 billion in assets on the Lyxor platform had net short position of 2.6 percent, indicating a loss for them given the currency move.

The euro dropped as much as 30 percent below the 1.20 cap to 0.8500 franc per euro at one point on Thursday before rebounding to roughly 1.04. The dollar plunged to 0.736 franc, its lowest since 2011, before paring losses. It was last trading at 0.894 franc, down 12 percent.

Hedge fund portfolio positioning at the start of the year indicates that commodity trading advisors, hedge funds that use computer-driven models to evaluate risk, pricing and timing in financial markets, stand to gain.

"This is one of those moments where some people would have been lucky. Many more people, I suspect, would have been unlucky because they would have positioned with the policy of the central bank," said Morrison, whose fund profited from the move.

One of the winners was Sunny Dhonsi, a former JP Morgan trader who left last year to set up Govardhan, primarily an opportunistic equity hedge fund. He had bought puts on EURCHF with a 1.20 strike price.

These puts, a bet on the euro falling against the franc, were cheap because of how aggressively the Swiss had defended their currency. He said with the European Central Bank poised to boost its own monetary policy, the SNB was looking at having to purchase even more euros in order to defend the franc.

"We didn't put on the trade thinking they would lift the cap so soon, just that the options were too cheap and totally mispriced," he said.

However, other computer-driven funds that base their models on historic volatility may have been exposed because the cap has dampened volatility in the franc for the last few years.

CTAs returned nearly 10 percent last year, according to data from industry tracker Eurekahedge, nearly three times the average gains in global macro hedge funds.

"CTAs will win from today's move, global macro may lose and that will be a repeat of the developments that we have had in recent quarters," said Philippe Ferreira, head of research at Lyxor Asset Management.

Kevin Hoffmeister, a broker for RCO Financial who mainly deals in currency markets, said he was shocked when he strode onto the trading floor in Chicago. Because the news came out during London trading hours, the "initial shock and awe was over," but he still said "everybody was stunned."

Hoffmeister was unsure whether the SNB will take more action.

"No one thought they would do this," he said of scrapping the cap. "Will they telegraph it any better next time? Maybe. It caught a lot of people off guard."

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