Because They Knew What They Were Doing: The Parallels between European and SNB Leaders

 

 

Roth Hildebrand 2007

Roth and  Hildebrand

In 2007, the SNB leaders knew about the strong franc’s undervaluation despite the very strong Swiss trade surplus. There were many warnings that the global real estate bubble was likely to explode, and this would lead to a rapid franc appreciation. But SNB leaders continued to weaken the Swiss currency. Still in 2007 Swiss inflation pressures were low and SNB leaders could still identify an output gap (see more in our history section on the undervalued franc).
The same picture for the European currency, the euro. From the very beginning European leaders knew that they were building an ill-constructed currency. That’s at least what the Swiss papers now think about the European system. The papers ignore that a similar situation occurred with the valuation of the Swiss franc between 2005 and 2008.



 

Jacques Delors Pohl Diem Markus Meier and Tina Haldner from Finanz and Wirtschaft wrote:

“Today we know it, the Euro zone with its current institutions can not function. But its planners knew already exactly 23 years ago.”

 

We reckon that the Swiss National Bank was similarly aware that the franc was strongly undervalued in 2007 and 2008 given the huge current account surpluses together with huge capital exports from Switzerland.

 

 

 

 

110% of the Swiss current account surplus was exported between 2005 and 2008 via capital transfers to the European periphery, Eastern Europe and other countries that were promising a higher return than Switzerland. A nice parallel to the Target 2 balances.

Financing of Swiss Current Account Surplus

Swiss current account surplus and its capital export (source SNB)

 

Austrians and Eastern Europeans signed mortgages in francs, thus weakening the Swiss currency even further. Swiss companies kept on holding their profits in foreign currencies.

Already in 2007/2008 the OECD was saying:

Switzerland has had a long-standing surplus on its current account. But over the past 15 years that surplus has surged to levels unmatched by nearly any other OECD country at any point. This paper looks at the surplus from a balance of payments vantage point as well as from the optic of the excess of national saving over domestic investment. It then seeks possible explanations for the uptrend and assesses whether it results to any extent from market, institutional or policy failures that could call for reforms. A number of important measurement issues are raised. But the key recommendation is that the authorities should prepare for a possible sharp increase in the value of the Swiss franc if and when investors engaged in the “carry trade” unwind their positions. To that end they should examine labour, capital and product markets with a view to ensuring they are as flexible as possible and that factors are as mobile as possible, both geographically and sectorally. This will allow any necessary adjustment to a higher exchange rate to be smoothly accommodated. This Working Paper is largely extracted from the 2007 OECD Economic Survey of Switzerland (www.oecd.org/eco/survey/switzerland).

Source OECD

This was not the only warning that the global real estate bubble was likely to explode, and this would lead to a rapid franc appreciation.   Many used the CHF as the financing currency in carry trades. The following graph shows the carry trade between euro and Swiss franc, visible in the COT Net Speculative Positioning. Till summer 2007 speculators were strongly short the franc in order to invest in high-yielding currencies, one of them was the euro. Still in 2007, speculators were short CHF with up 80000 contracts with 100K CHF contract size each.

EUR/CHF and COT Net Speculative Positioning 2007-2012

But SNB leaders continued to weaken the Swiss currency in 2007 and 2008, leaving the Swiss Libor far lower than ECB rates, despite the huge export surplus and stronger Swiss GDP growth than in the euro zone. The consequence was that the SNB was forced to perform interventions at still undervalued levels of  EUR/CHF of 1.50 in 2009 and 1.40 in 2010, and that the 1.20 level is now close to fair value.

UBS Export-weighted exchange rate CHF

UBS’s Export-weighted exchange rate for CHF until June 2012

 

Since 2009, a big part of the Swiss current account surplus has been invested by the central bank, but not in gold at a fixed price, like in the Bretton Woods system, when Swiss gold reserves were constantly rising. In 2012, the SNB invested the Swiss surplus mostly in fiat currencies and to about 10% in gold that is in real terms far more expensive than the 35 US$ during the Bretton-Woods period.  Moreover, these investments in fiat currencies, in US or German government bonds yielded close to 0% per year and were priced at record-highs, in particular when most interventions were done in 2012.

The most interesting thing is that the Swiss current account became bigger between 2009 and 2012 despite the ever rising franc. Clearly a situation that is not sustainable in the long-term: one day the peg must be removed.

 

Deutsche Bank: Swiss Current Account Like Strong Franc

Swiss Current Account Likes a Strong Franc (source Deutsche Bank)

 

Recently Daniel Gros put it in “An overlooked currency war in Europe” as follows:

Capital outflows are considered an equilibrium phenomenon during the upswing of a credit cycle, but capital inflows during the downswing are ‘speculative’ and must thus be neutralized.

 

We think that at a later point in time, in maybe 5 or 10 years, with the start of Swiss inflation, all these issues will be discussed in detail, perhaps in a parliamentary commission. Then it will become clear that:

Similar to European leaders who knew what they were doing, it will be shown that the SNB exactly aware what they were doing between 2005 and 2008,

namely the absolutely wrong thing.

The former created a common currency for completely different peoples. Between 2005 and 2008, the latter allowed the huge Swiss current account surplus to be used as a means of financing the global carry trade and “cheap” mortgages within a huge European real estate bubble.

Read about the second huge mistake of former SNB chairman Roth, selling the Swiss gold reserves for far too cheap. It resulted in an unrealized gain of 42 billion CHF. It the SNB had kept its gold reserves then the bank would have survived the franc appreciation after 2008 without any losses.

 

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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Further Reading:

Jarrett, P. and C. Letremy (2008), “The Significance of  Switzerland’s Enormous Current-Account Surplus“, OECD Economics Department Working Papers , No. 594, OECD Publishing. doi:10.1787/244253177344

The Risks on the Rising SNB Money Supply

Since the financial crisis central banks in developed nations increased their balance sheets. The leading one was the American Federal Reserve that increased the monetary base, which recently had also an effect on banks’ money supply. For the Swiss, however, the rising money supply is far stronger than in the euro zone and than in the United States; therefore the risks are higher.

The Monetary Base

Monetary Expansion SNB

M0, central bank money or monetary base (MB) are sight deposits of domestic banks at the central bank plus the bank notes. In 2012, the total amount of Swiss bank notes increased quite slowly, as opposed to sight deposits.

 

Is more and more “money” dangerous?

 

Money Multiplier M1 M0This is the ordinary theory:
If a central bank prints more money, then domestic banks have more funds available to give loans and mortgages. Via the money multiplier they are able to generate far more money than the central bank actually provides with M0.

This is the old text book approach. There were the times when banks were “fully loaned up”, meaning that they hit the limit of minimum reserve requirements, something which the case in China or other Emerging markets.

Nowadays things are a bit different in Western countries: Via quantitative easing central banks of QE countries purchase back their own government bonds from insurances or pension funds, so that those investors convert these holdings in more risky assets. Since investments are global in our day, the effect spills over into (risky) assets in Emerging Markets (EM). The consequence is that investments and wages in EM rise excessively and the currency of QE countries depreciates. This is positive for the QE countries because it reduces the competitiveness gap. Thanks to the closing of the competitiveness gap it has helped U.S. home prices, since 2013 U.S. manufacturing to recover.

The QE effect also spills over into nations like Switzerland and helps to push up Swiss asset prices and the Swiss franc. The SNB had the choice between a stronger currency and an excessive appreciation of the Swiss assets. It opted for the first and increased its monetary base massively in order to absorb foreign currency inflows. Implicitly the central bank helped to push up asset prices even further.

Hence it was rather foreign demand for Swiss assets that helped to increase the demand for credit and money in the real economy. And the final answer is: Yes, more and more money is dangerous.

 

Countries like the US, Spain, the UK or Ireland saw monetary aggregates rise quickly between 1999 and 2007. The European monetary union saw increases of 8% per year, but nominal GDP growth was around 5%.

Europe M3 CreditThe following graphs show, that credit to Swiss private borrowers rose in line with nominal GDP growth between 1994 and 2007. When both growth variables rise with the same pace, then the growth is considered healthy (especially by monetarists and Austrian economists).

The SNB printed a lot of money especially in the years before and just after the euro introduction until 2003, to weaken the franc and the “presumed slow” Swiss growth. The money increase, however, did not affect credit growth more than it should have: investors preferred other countries to Switzerland to buy assets. Finally the central bank increased interest rates a bit and reduced money supply between 2006 and 2008 (in 2006 smaller Raiffeisenbanks were integrated into the statistics for M3).

Since 2009, things have changed M3 is rising with an average of 7.7% per year., while before 2009 it was 3% per year. Banking lending to the private sector is increasing by 3.9% per year while it was 1.7% between 1995 and 2005.

Swiss M3 and Lending 2014 Ireland

 

Some say that the reason for more loans and mortgages were the bilateral agreements between Switzerland and the EU that allowed for more immigration into Switzerland. But these agreements date from 2004 and the effect would have shown up already before.

The SNB is fully aware of the risks. SNB’s Danthine shows the sharp increase of the credit to GDP ratio in several countries (source). For him the reasons were:

  • Improved credit access due to structural reduction of supply side constraints (financial liberalization, innovation)
  • Structural increase in credit demand (e.g. growth opportunities, cultural changes or demographic shift)
  • Extended period of low interest rate
  • Overconfidence and misjudgement of borrowers and/or lenders (behavioural biases)
Swiss vs EU Credit to GDP SNB Danthine

source SNB

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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SNB First Quarter Results: 1.7% annualized Yield on Seigniorage, 2% annualized Loss on FX Rate Change


The main task of a central bank occupied with QEE (quantitative easing or exchange intervention) is to obtain higher gains on seigniorage than it loses with its “ever appreciating” currency. Otherwise its equity capital would be absorbed. In the first quarter of 2014, the Swiss National Bank (SNB) was unable to accomplish this task:

The seigniorage effect yielded 1.7% annualized thanks to interest and dividend income but the FX rate losses were 2% annualized.

SNB Results Q1/2014 

 

The Swiss National Bank (SNB) reports a profit of CHF 4.4 billion for the first quarter of 2014. The profit on the foreign currency positions amounted to CHF 1.7 billion. A valuation gain of CHF 2.6 billion was recorded on gold holdings.  (source SNB)

Winning Positions are the ones that lost in 2013

  • P/L for gold: 2.6 bln. CHF after a loss of -15.2 bln. in 2013
  • Valuations of government bond holdings:  2.3 bln. CHF

 

Losing Positions are:

  • According to the release “Exchange rate-related losses amounted to CHF 2.7 billion in all”, this is an 0.5% on the 495 bln. balance sheet or a 2% annualized loss. We look at the change in FX rates in detail:
    • USD, 27% of the portfolio, at 0.8844 in Q1 after 0.8873 at the end of 2013
    • JPY, 8%, at 116.70 in Q1 after 118.23 at the end of 2013  –> a loss of around 0.5 bln.
    • EUR, 47%, at 1.2182 after 1.2252 in Q4/2013.  –> This is the biggest losing position in Q1 with a 1.4 bln loss
    • GBP, 7%, at 1.4739 after 1.4773 in Q4/2013
    • CAD, 4%, at 0.8001 after 0.8336 in Q4/2013 –> another loss of 0.8 bln.

The sentence from the official release “Exchange rate gains on the Japanese yen did not offset the losses recorded on other investment currencies, particularly on the euro, the US dollar and the Canadian dollar.” is rubbish. Yes, in 2013 the yen lost the most, but not in Q1/2014.

 

Seigniorage: 2.1 bln. compared to a 495 bln. balance sheet gives a 0.42% yield in this quarter, or a 1.7% yearly yield. This implies that the SNB will be able to afford a EUR/CHF of 1.10, a depreciation of 10%, in roughly six years.

There are two scenarios when this depreciation to 1.10 may happen

  1. Rising US and euro zone inflation without major improvements in the labor market.  More details here.
  2. A Swiss boom and further pressure on the SNB as for real estate prices that require a rate hike. More details on the Swiss boom here.

 

The third scenario is the above mentioned fight between seigniorage income and FX rate losses. Typical QEE nations like Singapore are constrained to let their currency appreciate over time against inflationary pressures. We still need to mention that gains on equity prices are not included. Still one needs to examine if current equity valuations reflect economic reality or more the possibly only temporary QE effect.

In 2012 Thomas Jordan rejected demands by the people’s party politician Kaufmann to create a sovereign wealth fund, a method used by other QEE countries like for example Singapore. Possibly Jordan thought that Switzerland were no QEE country, but a safe-haven like Japan, a country nearly without immigration and with a trade deficit, in short the opposite of Switzerland.

 

 

Read also:

Will SNB FX Investments Yield Enough Until U.S. Inflation Starts?

What Ernst Baltensperger Got Wrong: Why SNB Losses Might Not Be Recovered By Income on Reserves

SNB has Won the Risk Aversion Battle, When Will the Inflation Battle Start?

Why the SNB will not Imitate Hong Kong, but Potentially Singapore

For comparison, the reader can obtain the results for 2013 on the second page, or via the page navigation below.

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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Rising Sight Deposits at SNB Means Rising SNB Debt

The financing of SNB currency purchases is currently realized by increasing SNB debt to local and international banks and companies, commonly called “money printing”. These loans from banks and companies to the SNB have increased to a total of 371 billion francs at end 2012, by 150 bln. CHF in one single year. Together with the SNB equity and 53 billion of bank notes, sight deposits build up the so-called “monetary base” (sometimes “central bank money” or “base money”), or from the banks’ perspective “reserves”, nearly all of them “excess reserves”. They are used to finance the current total of 485 billion CHF in central bank assets, of which as of end 2013, 8% are in gold.


To give the reader a big picture: When the sum of current account and capital account (excl. central bank) is higher than zero, then central banks must absorb the difference. A second effect, a "supply and demand effect" is that the currency appreciates. The major reasons for a stronger currency are hence
  • Positive current account: Local companies have higher profits than foreign companies - reflected in a trade surplus.
  • Positive capital account: more foreigners buy local assets, invest in the local country or pay back loans or lend to locals than the opposite (i.e. locals acting abroad). Hence capital inflows are higher than capital outflows.
See more in the Swiss balance of payments. If the central banks is not ready to accept the currency appreciation, e.g. because it thinks that capital inflows are only temporary, it intervenes in markets. Swiss National Bank Assets and Liabilities Sight DepositsBetween 2009 and 2012, both current and capital account were strongly positive, hence the SNB had to intervene heavily. Since 2013 the difference has become small (slightly negative or slightly positive) because more capital is leaving Switzerland, while the current account is still strongly positive. The table shows the major entries of the SNB balance sheet. The interventions were the results of failed monetary policy between 2004 and 2008 when the SNB tolerated a weak franc despite strong current account surpluses and the financing of real estate bubbles with "cheap francs". (see more).

Even if Switzerland counts only 8 million inhabitants or 30 times less than the United States, its central bank has a balance sheet that is only 8 times smaller than the one of the Fed. The risk and volatility is even higher, the Swiss possess nearly exclusively foreign assets; the Fed or the Central Bank of Japan mostly own local government bonds, the two do not have a currency risk.

Cumulative Change Central Bank Balance Sheets

 

This link to the SNB website gives insights into how many francs the Swiss National Bank requested commercial banks to deposit, here our detailed overview of the weekly change since the beginning of 2012.

Whenever somebody anywhere in the world wants to buy a Swiss asset, a Swiss house, a Swiss stock or just francs in cash and the price comes close to EUR/CHF 1.20 or the equivalent in other currency, then the SNB  says: “You can get it cheaper than the usual market price, I will give you francs, you give me the foreign currency.” All central banks obey to simple accounting procedures. With more foreign currency aka assets, the central bank increases also its liabilities.

The increase of debt is sometimes called “money printing”. Money printing is just a technical accounting process, but not printing real bank notes. It means Minus (or liability) for the SNB, Plus (or more assets, more reserves) for the banks. Keep in mind that in the case of interventions the central bank is the initiator of rising bank reserves, and not as usually the lending process. If the SNB had not intervened the whole process would not have touched the SNB balance sheet, but the EUR/CHF price would have been far lower than 1.20.

The following graph from UBS confronts the increase of SNB assets with the rise of liabilities.

SNB Assets vs. Liabilities src. UBS

SNB Assets vs. Liabilities (source UBS)

 

Between summer 2011 and autumn 2012, sight deposits at the central bank have increased very strongly. Until summer 2011, the SNB converted sight deposits into SNB bills and reverse repos, it sterilized them, i.e. it fixed them to an interest rate in a “bill contract”. But now nearly the whole debt is unsterilized, the interest rate is variable. Only thanks to low inflation and “favorable” market conditions this rate is currently zero percent. If there were sufficiently profitable lending possbilities around, then banks could use retreat the funds from the SNB and obtain a higher interest rate with another bank or change them into cash. This is valid in particular when the interest rate were negative.

About 75% of deposits are at local banks (more details here).

The causes of the rise in sight deposits are:

  1. The Swiss current account surplus, namely when Swiss companies deposit their foreign gains in a Swiss bank in Swiss francs.
  2. Risk-Off Flows: Foreign safe-haven flows in deposits in Swiss francs either at foreign banks or at Swiss banks. Some of those are Swiss that sell their foreign investments or that closed their leveraging based on CHF.
  3. Risk-On Flows, in particular between May 2012 and September 2012
    a) More foreigners buy Swiss equities than Swiss buy foreign equities.
    b) Foreigners give more loans to Swiss than Swiss to foreigners.Consequently a difference appears and higher demand for CHF than for euros. In order to keep to the CHF cap, the SNB increases its liabilities with Swiss banks, buys CHF for the difference and invests it again – often in foreign stocks.
  4. The SNB sold sterilized positions in SNB bills and reverse repos in summer 2011 and replaced them with unsterilized sight deposits.

The safe-haven flows under 2) that after some months or years look for a new destination. But the risk-on flows can be dangerous for the SNB, when this mass of deposits are mirrored at least partially by new loans and mortgages, more see below. More details are available in our section on the Swiss balance of payments.

If the SNB gave up the peg and the EUR/CHF fell to 1.00 in line with other currencies, then the Swiss would lose around 60 billion francs, 10% of the GDP (details here).

In September 2012, the Thomas Jordan said that the main reason for the strong franc is the conversion of Swiss foreign incomes into francs. The graph shows that this is not the case. The main drivers of SNB reserves is the continuing trade surplus.

SNB Reserves vs. Current Account Trade

data source: SNB’s IMF data

A history of SNB sight deposits during this year is available here.

What does increase of sight deposits or M0 mean?

Monetary Expansion SNB

M0, central bank money or monetary base (MB) are sight deposits of domestic banks at the central bank plus the bank notes. In 2012, the total amount of Swiss bank notes increased quite slowly, as opposed to sight deposits.

Sight deposits are often called “reserves” from the point of view of commercial banks, they are assets for the banks and liabilities for the central bank. Since economists are not strong financial accountants, they also called assets of central banks “reserves”,too. Hence central banks possess “FX and gold reserves”, but they owe “minimum and excess reserves” to banks. In Switzerland reserves owned by banks are far higher than the SNB reserve requirements, they are hence mostly “excess reserves“. As opposed to the Fed or BoE, the SNB does not pay interest for these excess reserves. Since 2012 even the ECB does not pay interest in its deposit facility.

Therefore, the increase in sight deposits should correspond, roughly, to the same increase in FX reserves, when changes in prices are excluded: for example, 2.6 billion more money at the central bank (M0) printed to buy 2.6 billion more FX reserves.1

More details in our detailed explanation of money supply.

An example for the monetary data is given here. Sight deposits rose by nearly 18 billion francs in one week in June:

SNB Sight Deposits May 25

The increasing SNB liabilities are visible in the balance sheets of commercial banks, here the one of Credit Suisse, the net assets to central banks have increased to 68 bln. CHF.

While in 2005 Credit Suisse was lending to foreign central banks (e.g. in 2005/2006 to the Fed) in order to profit on higher interest rates; but now the SNB is the principal borrower.

How do price changes affect money supply and FX reserves ?

When the EUR/CHF rises by 1% and deposits are increasing, then the SNB must pay more for one euro than previously. A number of 18 billion CHF more Euro reserves – e.g. in the week ending in June 1, 2012 as above – would imply that the SNB had to pay 1% more, namely 18.18 billion francs.

Given that Swiss inflationary pressures will rise one day, any pip paid more implies inflation and more potential losses. It is clear for us that the SNB does not want to pay more than 1.2000 for one euro.

 

The Limits of Money Printing

Theoretically banks could tell the SNB not to credit their accounts any more or even withdraw the funds. They will hesitate in particular when other banks offer higher short-term CHF interest rates (CHF Libor rates) – possibly when inflation rises. At that moment, the SNB would need to compete with these banks.

This would prevent the SNB from printing. If high inflationary pressures show up, then banks could require a clearly higher interest rates than nearly zero percent. This would lead to quasi-fiscal deficits caused by the central bank.

Most banks think that the SNB is able to get rid of most of their currency reserves one day or is able to reduce sight deposits and sterilize the funds in SNB bills. SNB’s Dewet Moser writes in this paper how easy it was to sterilize during 2010 and 2011. However, he does not speak about the fact that the Swissie was strongly rising during this sterilization process.

 

Money Printing in the Euro System

Inside the euro system, ECB money printing via deposits at the ECB means debiting the account of the ECB and crediting the accounts of the National Central Banks (NCBs) of the euro system for their participation in the ECB. This method, as used in the ELA (emergency liquidity financing), is done according to the following schema:

Eurosystem Participations per Country

Euro system Participations per Country (source ECB)

30% of the ECB capital belongs to non-euro states like the UK, Sweden, Denmark, Poland or other non-euro EU member states.

Printing money means that the ECB increases its debt towards the NCBs in the ratio of the euro system participation, namely Bundesbank 27%, Banque de France 20%, Banca d’Italia 20% and Banco de Espana 12%.

If the ECB buys peripheral bonds with this money, it implies an implicit transfer from the Bundesbank and the Banque de France and other Northern states to the periphery. The Bundesbank will refinance this money via increasing its debt at German commercial banks, if it does not collect the liquidity again by repurchase agreements.

Increased liquidity results into more reserves which they might invest via the money multiplier to give more loans to German firms and housing. Apart from more and more debt due to Germany, this operation will increase inflation over the medium and long-term.

The ECB often employs tenders (via SMP, MTO, LTRO or OMP) to allow commercial banks to refinance her directly. In this the case banks’ reserves at the central bank do not increase; therefore, it is also called sterilized. Since these lending banks mostly come from Germany and other Northern states, it is just another form of money transfer from the Northern states to the periphery.

Further Readings

The article “Definitions of money supply in the context of the SNB” gives the basic understanding of the underlying concepts.

The paper “Quantitative Easing, its Indicators and the Swiss Franc, Update FOMC September 2013” shows why in the United States and Japan the monetary base is rising far more quickly than money supply and why Quantitative Easing, i.e. the relentless increase of the monetary base (without FX transactions) is becoming useless; it cannot increase money supply and inflation.

The article “The Risks on the Rising SNB Money Supply” explains why in the Swiss case a rise of the monetary base may increase money supply and inflation.

Read the full details about the differences in money printing between the SNB, ECB and Fed in our article “The big Swiss Faustian Bargain” which also appeared on Zerohedge.

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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References
  1. The SNB has not employed swaps or repos since April 2012. Swaps or repos may distort the picture. []

SNB Balance Sheet Expansion

 

Since 2008 the Swiss National Bank has expanded its balance to 280% of GDP. So did most other central banks, too. But there is one big difference: The risk for the SNB is far higher, the SNB possess mostly foreign assets.

The Fed or the Central Bank of Japan mostly own local government bonds, they run an inflation risk but no currency risk.

Cumulative Change Central Bank Balance Sheets

The following graph from UBS shows how the SNB has increased both assets and liabilities, its balance sheet expansion.

 

SNB balance sheet expansion

SNB balance sheet expansion (source UBS)

 

 

SNB Reserves vs. EURCHF

SNB Reserves vs. EUR/CHF (G. Dorgan based on UBS)

We like to compare the increases with the fall of the EUR/CHF exchange rate.

The graph shows that a decrease of reserves was only possible when EUR/CHF appreciated. Maintaining the EUR/CHF relatively stable was only possible when reserves strongly rose.

  • Between March and June 2009, the SNB managed to maintain the 1.50 EUR/CHF “line in sand” only thanks to intensive FX intervention.
  • Same picture in May 2010: Strong demand for the Swiss Franc, even multiplied by the first Greek crisis. The EUR/CHF fell to 1.40. When the SNB had abandoned the FX interventions the Swiss Franc reached parity with the dollar and EUR/CHF 1.30 in September 2010.
  • After the typical US rebound in Q4/2010, the Swissie soared again. Like regularly it reached a first peak in the May 2011 up to a EUR/CHF 1.22 and a USD/CHF of 0.83. Then the increase of the Swiss currency even accelerated to reach EUR/CHF of 1.0076 and USD/CHF 0.71 in August 2011.

 

 

The following tables show the SNB balance sheet in comparison to the one of the Bank of Japan, another central bank that strongly intervenes in markets.

SNB vs. BoJ Balance Sheet

SNB vs. BoJ Balance Sheet (source SNB and BoJ)

 

As said, the huge difference is that the Swiss buy foreign assets and foreign currency whereas the Japanese possess only 5% foreign assets, see more details.

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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The Big Swiss Faustian Bargain: Differences between SNB, ECB and Fed Money Printing Explained

In this post we show that the risks the Fed, the ECB and the Bundesbank incur are far smaller than the one the Swiss SNB takes. The Fed has “just” an inflation risk, that could cost 200 billion US$, 1.2% of US GDP. The ECB and Bundesbank have the risk that  the euro zone splits up. In this case the Bundesbank will sit on 700 billion € of devalued peripheral assets. In a case of 30% currency devaluation for these assets, they might go for losses of 5% German GDP.  The SNB, however, possesses assets of 350 billion € in  foreign currency. A 18% franc revaluation to EUR/CHF parity would give them a loss of 60 billion €, 12% of Swiss GDP.

(This post appeared in smaller version on Zerohedge)

Mephistopheles and the Roman Emperor

In a scene from Goethe’s tragedy, Mephistopheles persuades the heavily indebted Roman Emperor to print paper money – notionally backed by gold that had not yet been mined – to solve an economic crisis, with initially happy results until more and more money is printed and rampant inflation ensues.

Most recently, Guggenheim Partners showed in their “Faustian Bargain of Central Banks”, which also appeared in the FT, that the Fed could lose 200 billion US$, when inflation comes back again. Interest rates would increase by 100 basis points and the US central bank would be bankrupt according to US-GAAP.

We explain in this post the differences between money printing as for the Swiss National Bank (SNB), the ECB and  the Fed. We show the risks the central banks run when they increase money supply, when they “print”.

This link to the SNB website gives insights into how many francs the Swiss National Bank requested commercial banks to deposit during the last week. It is just a technical accounting process: Minus (or liability) for the SNB, Plus (or assets) for the banks. Therefore it is often called “printing”, like adding a zero to a currency exchange rate. The SNB uses this “electronically printed” money to buy more and more currency reserves and to enforce the CHF cap against the euro. At the same time printing increases the banks’  excess reserves at the central bank.

A simple view of the operation is the following:

SNB Printing Money

SNB Printing Money for more FX Reserves

In August/September 2011 the SNB bought back their “SNB bills” and liquidated swaps.  Since then each time, when the SNB buys FX reserves, the increase in bank deposits, i.e. SNB debt at banks, moves nearly in-line with the increase of FX reserves. See more explanation about the SNB printing measures and who profits from it here.

SNB Graph FX reserves Money July27

 

The Limits of Money Printing

 

The following graph from the SNB former chairman Hildebrand (2004) shows that a period of inflation had regularly followed the SNB monetary expansion with a delay of about 2-3 years.

Price Inflation follows Monetary Expansion

Price Inflation follows Monetary Expansion (Source Hildebrand SNB), For the differences between the different money aggregates see here.

Broad money supply M1-M3 is rising by around 7% per year. But M0, in particular the deposits of commercial banks at the SNB rose far more quickly. The reason for the masses of deposits is definitely not that Swiss banks are reluctant to lend. In order to stop excessive lending, the SNB had ideas for an anti-cyclical capital buffer in order to stop excessive mortgage loans practices and preserve banks’ capital for a possible downturn. Many people fear the a similar bust of the Swiss real estate bubble like in the 1990s.

Theoretically banks could tell the SNB not to credit their accounts any more, they obtain 0% interest. This would prevent the SNB from further printing. We discuss this including potential negative rate here.

The SNB thinks it will be able to get rid of their excessive sight deposits either:

  1. when banks want to sell their francs again and and/or
  2. when the SNB sterilizes the deposits – when it pays back the quickly available sight deposits debt to the banks and converts them into longer-term SNB bills. The deputy member of the SNB board, Dewet Moser, proudly presented in this SNB paper how easy it was to sterilize between May 2010 and July 2011 (see also in the reserves overview above). However he does not speak about the fact that the Swissie strongly appreciated (from EUR/CHF 1.40 to 1.10) during that period and the SNB had to accept huge losses at the end of 2010.

 

Money Printing in the Euro System

Money Printing and Eurosystem Participations

Eurosystem Participations

Inside the euro system, one important method of money printing is debiting the current or deposit account of the ECB and crediting the accounts of the National Central Banks (NCBs)  according to their participation in the Euro system. The member states of the operations are executed along the following schema:

30% of the ECB capital belongs to non-euro states like the UK, Sweden, Denmark, Poland or other non-euro EU member states. This 30% is removed in order to obtain their participation in the euro system. Printing money in the case of “emergency liquidity assistance” (ELA) means that the ECB increases its debt towards the national central banks (“NCBs”) in the ratio of the euro system participations, namely Bundesbank 27%, Banque de France 20%, Banca d’Italia 20% and Banco de Espana 12%.

The different “printing money” operations have different names (source Zerohedge, JP Morgan):

ELAs (emergency liquidity assistance) – an ELA is a facility introduced by the individual national central banks (only by ECB approval) designed to allow banks that would otherwise be locked out of normal ECB operations to secure liquidity.  Ireland and Greece both have ELAs (although other CBs may have undeclared ELAs open too) and other countries could introduce these facilities.  For the ELA, the national central bank is on the hook for any losses (vs. the overall ECB).

ECB Liquidity tenders – the ECB currently conducts liquidity operations in 1-week (“MRO” or main refinancing operations) and 3-month intervals (“LTRO” or long-term refinancing operations).  Europe’s banks can take eligible collateral to the ECB in unlimited amounts and borrow against it w/appropriate haircuts.  Recall the ECB recently conducted two 36-month liquidity operations and in theory could launch tenders for any interval of time (6-month, 12-month, 24-month, etc).  However, Europe’s banks may not have a ton of eligible collateral left, making future LTROs less effective than the ones from 2011.  Keep in mind too ECB politics are a factor as these operations start to have longer maturities – recall that the ECB eased collateral standards for the second 36m operation but allowed each individual central bank to make the final determination (and some, like the Bundesbank, kept collateral standards unchanged).  The next ECB meeting comes up June 6 and there has been some spec of them doing an LTRO less than 36m (something like ~12m).

ECB SMP (Securities Market Program).  This was introduced back in May 10 and while it has been dormant now for several weeks (it hasn’t been used since late Mar), in total there have been ~EU215B worth of sovereign bond purchases made via this facility.  The SMP is a redirection of liquidity as all purchases are “sterilized” (this is a key difference between the SMP and the Fed’s QE – the Fed’s purchases are “unsterilized” and represent a net injection of liquidity).  In theory, there is no limit to the SMP although in reality there are (due to political constraints but also b/c of sterilization limits – recall the ECB once last year failed during one of its sterilization attempts).  Back in the summer/fall of 2011, the SMP nearly bought EU10-15B during some weeks (you can see the amounts under “ECBCSMPW Index” on Bloomberg) but it isn’t clear that purchases at those levels can be sustained for long (keep in mind that certain ECB officials, inc. former Bundesbank head Axel Weber, resigned over this program).

By September 6, 2012 the SMP has finished. According to Draghi the size of the SMP was about 3% of euro zone GDP.

 

The blog “Place du Luxembourg” gives an overview of some more of these ECB operations.  These ones were referenced above. The current accounts and deposit facilities (“access at the discretion of the counter parties“) corresponds to the ELAs. The monetary base M0 is increased in this case.

ECB monetary policy operations

Some other ECB monetary policy operations (source Place du Luxembourg)

 

As opposed to the ELAs, the NCBs do not provide liquidity with  the “main refinancing operations” (MRO) and the “longer-term refinancing operations”.

In this case commercial banks have the choice to lend money to the ECB directly, to provide “printed money”.

It is clear that currently not only the peripheral states, but German and other Northern banks have money left to lend to the ECB. The lending to the ECB is commonly realized via reverse repurchase agreements (“REPOs”), where the ECB purchases securities (mostly government bonds) from the banks and sells them after one week (MRO) or three months or more (LTRO) plus some interest. If the periphery requires further funds, one can understand that after this week or three months, the ECB will do another market operation with an even higher total quantity of debt to Northern commercial banks. Commercial banks choose reverse repos and get rid of some government bond holdings when the economy expands and government bond prices are expected to rise. At the same time the central banks are able to remove liquidity in the form of deposits, which are too quickly available. The SNB terminated her latest reverse repo operations in May 2012, when the US-driven recovery was over. Since she has relied only on deposits.

If the ECB buys peripheral bonds with this “printed” money, it implies an implicit transfer from the Bundesbank and the commercial banks of the northern states towards the periphery By nature of the bad ECB assets (aka government bonds of the periphery) this is also sometimes called “qualitative easing”. 

The Bundesbank losses could be partially realized, when one day a country leaves the eurozone (either Germany itself or some peripheral countries) and an exchange rate difference among the former euro zone members appears.
What does “partially” mean? We saw already similar discussions in March 2012, when it had to be decided, if private or public entities take the losses in Greek government bonds, the pari passu. One day, maybe in a couple of years, the ECB or the Bundesbank and the public entities could also need to take losses, a haircut.

 

The Outright Monetary Transactions (“OMT”) Program

 

By September 6, 2012 the ECB introduced the new Outright Monetary Transactions (“OMT”) program. On one hand, it provides unlimited ECB interventions, on the other hand it requires conditionality. Moreover it stipulates that the pari passu is introduced even for public entities like the Bundesbank and ECB, their senior credit status is lost inside this program.

The table below summarizes these features and considers their meanings and implications regarding the effectiveness of putting an end to market pressure and effects on moral hazard.

Click to expand, source Place du Luxembourg

 

Legal Considerations about Monetary Financing

 

Here is a good overview from Place du Luxembourg.

Monetary Financing is a construct rather than a specific issue clearly defined by law. The ECB offers a good overview here. Theoretically, monetary financing includes several dimensions. Legally however, my understanding is that as long as the ECB stays away from the primary market, it should be innocent of any such crimes against price stability, as this is the only act explicitly forbidden by Article 21, Chapter IV of the Protocol on the Statute of the ESCB and of the ECB in accordance with the principles laid out in Article 101 of the Consolidated Treaty on the Functioning of the EU. Nonetheless, the pari passu status of the ECB on these (risky) purchases exposes the central bank to accusations that it is not “preserving the integrity of the central bank’s balance sheet“.

 

The Potential Tax-payer Bailout of the Bundesbank: Costs 5% of German GDP

 

German Bank vs. Target2 Debt

German Banks vs. Target2 Debt (source Thompson Reuters)

The Bundesbank refinances the credit to the ECB (current account and deposit facility), via an increase of its debt at German commercial banks. These again will possess more reserves. Based on these they may give more loans to German firms and housing. This operation will increase inflation over the medium and long-term.

Before 2008 Spanish banks were refinanced mostly directly by German commercial banks. After the crisis this completely changed.

The following graph give an overview of the of German banks’ deposits at the Bundesbank, i.e. the Bundesbank debt with German commercial banks.



 

 

 

Bundesbank Foreign Assets

Bundesbank Foreign Assets (source Querschuesse.de)

On one side the Bundesbank has more and more liabilities with German banks. On the other side the graph to the right shows how much foreign Bundesbank foreign assets have risen over the years

A future haircut of 30% on peripheral positions (about 700 billion € of the total 1000 billion foreign assets), would cost German taxpayers, 210 billion €, 5% of German GDP, more than the Bundesbank equity. This haircut would require German tax-payers to bailout the German Bundesbank. See more about why Weidmann has finally realized this problem together with inflationary risks in his critics with the ECB.

In order to avoid the bankruptcy of the Bundesbank, Merkel wants to introduce implicitly a “Euro Gold Standard”, a euro that is dominated by German stability and competitiveness, that, similarly as during the gold standard, forces weak countries into salary reductions and deflation. These weaker countries include the United States in a less stringent form, because the U.S. can still devalue and make U.S. labor cheaper via the currency. See more details.

 

 On this page we show more details on the German Bundesbank and clarify where the Target2 surplus is lying: Under German mattresses….

 

 

 

Update: Target 2 Balances by April 2014

 

Target 2 balances reflect two aspects:

  1. Current account surpluses (vigorously defended by Hans Werner Sinn)
  2. Capital flight (vigorously defended by Paul de Grauwe and Karl Whelan, et. al.)

 

Since 2012, the Target2 balances, have become tighter. Even if the periphery still shows negative current accounts, at least the capital flight part has become better: some money returned to the periphery.

The Swiss Faustian Bargain: Swiss Money Printing a lot more Risky than the Fed’s QE3

Guggenheim Partners showed in their “Faustian Bargain”, which also appeared in the FT, that the Fed would loose 200 billion US$, when inflation comes back again. Interest rates could increase by 100 basis points and the US central bank would be bankrupt according to US-GAAP.  For them this is the Fed’s Faustian Bargain with the Mephistopheles “inflation”. For us the SNB’s money printing is a lot more risky than the Fed’s Quantitative Easing. The graph shows where the Swiss problem lies:

Money Printing of Major Central Banks

Money Printing of Major Central Banks (Source Guggenheim Partners)

The SNB’s ratio of printed money to GDP is a lot higher than the one of the Fed. In case of inflation the Fed’s losses of 200 billion USD amount “only” to 1.2% percent of the US GDP. It would imply, as Guggenheim Partners state, a bankruptcy in terms of  US-GAAP. But still the Fed will be refinanced by the generous US tax payers.

The risks for the SNB, however, are eight to ten times higher: based on current FX reserves, it will cost at least 10% of the Swiss GDP, if Swiss inflation picks up and the Euro crisis will be not resolved till then.

As opposed to the ECB, the SNB only buys high-quality assets, mostly German and French government bonds. However , for the SNB the assets are in foreign currencies, for the big part they are denominated in euros. FX rates move a lot more quickly than American government bond yields do. This is a risk the Fed does not have, and neither the Bundesbank, as long as the euro zone does not split up.

Further Fed quantitative easing drives the demand for gold and the correlated Swiss francs upwards.  Sooner or later this will pump more American money into the Swiss economy and will raise Swiss inflation. At the extreme, an unlimited Quantitative Easing will bankrupt the SNB or force the tax-payer to bail out/recapitalize the SNB with an injection of 80 billion francs, 12% of Swiss GDP.

bernanke draghi Mephisto

The same applies for the ECB printing and the OMT: over the long-term this will drive money out of the euro zone and even out of Germany into Switzerland, because Swiss assets are more interesting and less risky and less-inflation-prone than the ones in the periphery. Moreover, a 12% higher Swiss debt is still far lower than Germany’s debt/GDP ratio.

None the less, these two are the Mephistopheles for the SNB: Bernanke and Draghi, the ones who promised an easy life based on printed money.

 

 

 

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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Will SNB FX Investments Yield Enough Until U.S. Inflation Starts?

Update September 2014:

For a longer time the SNB was able to maintain the floor against the EUR. While Swiss wages are rising by 0.7% per hour, but American and German hourly wages are up by more than 2% y/y. Taking account of falling unemployment, U.S. firms are now ready to pay a total wage increase of 7.5% annualized in Q1 and 5.8% in Q2. Costs for U.S. companies are increasing, but not really for Swiss ones. The question is now if this will translate into inflation, or if the global economic slowing will depress inflation also in the U.S.

In Q1/2014 CHF appreciated more than SNB was able to achieve in seigniorage. In Q2/2014, the bank obtained good results with the rising dollar thanks to Draghi’s euro bashing. The 2013 SNB results were even negative due to the falling gold price.
The following analysis gives a longer term picture.

Will SNB FX Investments Yield Enough Until U.S. Inflation Starts?

(written in April 2013)

Yield on Investment SNB Swiss National BankWe focus on income and yields for foreign exchange positions and gold in order to see if the SNB is able to survive a franc appreciation during an inflationary period in the U.S. and Europe.

These consideration will help us to see if the EUR/CHF floor is sustainable and if the Swiss might even achieve a gain on their investments.

  • In 2012 the SNB obtained its last gain on gold, while the central bank left the quantity of bullion unchanged. The gain was 2.9%. The share of gold against Fiat money has fallen from 27% in 2007 to 10%.
  • The SNB lost in particular on yen positions, value -12.7% and on dollar positions, -2.7% (we spoke about this when the first ad-hoc news came in January).
  • Despite the low interest environment, the SNB obtained an income of 5.644 bln. CHF on FX positions excluding the stabilisation fund, which is for our longer-term analysis not interesting. The interest yield is about 1.54% on bond positions, which are around 300 bln. CHF.
  • This yield is astonishingly far higher than current yields of the major SNB holdings (e.g. 5 year German BOBL or US treasuries, the current duration is 3.3 years).  Other assets (e.g. Italian, Spanish or Portuguese bonds) valued around 15 bln. CHF. They might have contributed to over 1 billion CHF with their higher yields. Moreover, the Swiss hold 6% in corporate bonds and some older and/or longer government bond issuances that should yield more.
  • Cash positions at other (central) banks with 85 bln. CHF, 17% of the SNB balance sheet,  do not earn interest. The unusually high portion of cash let suspect that the central bank wants to buy equities and/or bonds at cheaper prices.
  • The dividend income on the 40 bln. CHF equity investments (12% of the SNB positions) was around 1 bln. CHF, a dividend yield of 2.45%.
  • Adding up interest income and dividend income one obtains a total yield of 1.84%, which is around 1% less than in 2011. Since the SNB needs to replace redeemed bonds with bonds with higher yields, it can be expected that income on the SNB portfolio falls further.
SNB Income and Yield 2007-2012

SNB Income and Yield 2007-2012, Share of Gold

Only with a huge balance sheet expansion, the SNB managed to handle the 32% appreciation of the franc from 2007 against both the dollar and the euro. In 2007 the franc was undervalued against the euro with a EUR/CHF rate of 1.68. While the EUR/CHF fell to 1.50 in 2009, the SNB suffered already first losses due its early interventions against a still undervalued franc. Due to strong growth and some inflation signs, the SNB accepted the euro to fall to 1.24 by end 2010. Since 2010, the currency rose strongly against both euro and dollar, because it was stopped at 1.20 by the central bank. Most recently the EUR/CHF appreciated to its 2010 level of 1.24 again.

CHF against EUR USD since 2007

CHF against EUR USD since 2007

Our analysis shows that yields on investment are falling more and more, the not invested cash additionally reduces SNB profitability. If inflation rises again, then both SNB bond and stock positions could fall in price.

We suspect that future (limited) global growth will be driven by the United States, China and Germany (and with it also Switzerland), but a lot less than previously by other emerging markets (reasons forthcoming, one example here). Therefore we are pessimistic also for the gold price.

Apart from weak yields, this will lead to losses in all three types of SNB positions and answer the question why the central bank holds so much cash.

If however, there is a strong improvement for the American economy that triggers a rate hike in 2014 or 2015, then the Swiss franc could depreciate against euro and dollar. As it did after 1982 thanks to the Volcker moment.

The Fed’s policy with unlimited QE3, let us doubt very strongly that the U.S.will recover strongly as it did after 1982.

Given the current risk-on environment, the floor seems to be sustainable, but it will be in a future inflationary scenario?

 


George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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Swiss Franc and Swiss Economy: The Overview Questions

We would like to deliver the whole background, starting with the question why Swiss inflation has been so low in the past and why CHF always appreciated. 1) Why is Swiss inflation so low, when will this change? 2) Do you see EUR/CHF appreciate?

I’m a regular follower of your blog and I find your thoughts and research interesting and insightful. 3) I would like to learn more on your thoughts on CHF interest rates, 4) especially short term money market rates which are negative. 5) How long do you believe the negative rate pressures will continue? 6) Additionally, does the SNB’s sight deposit facility allow banks to hold unlimited about of excess reserves or are they limited by a cap? All thoughts will be greatly welcome. Many thanks Sunny,

Question 1) Why is Swiss inflation so low, will this change?

Unit Labor Costs and Inflation EMU

click to expand

Wages and inflation are very closely related (see graph). Swiss wages historically increased less than the ones in Europe or the U.S. This is the main reason why CHF had the tendency to appreciate. Currently Swiss wages increase by 0.7% per year. Swiss inflation is at 0.2%. A big part of the “real wage difference” can be explained by cheaper imports that still reflect the CHF appreciation phase. The rest is structural.     The historical reasons for the smaller Swiss inflation and the strong currency are:

  • Lower inflation and smaller wage growth imply smaller cost increases for Swiss companies. This is reflected in low interest and borrowing rates and in the interest rate parity.
  • Small borrowing rates lower the cost of capital for Swiss firms.
  • Immigration of (for Swiss levels) cheap personnel.
  • Thanks to attractively low personal tax rates, Swiss multi-nationals like chemicals, pharmaceuticals or banks are often able to pick the best qualified people world-wide. In the last 15 years many Germans took over high positions in Swiss companies.
  • Huge current account surpluses that are often not fully exported via the capital account. It is sufficient to buy stocks of Swiss multi-nationals to profit on global growth. Those invest globally imposing a sort of “Swiss/German governance” of companies and supply chains.
  • High Swiss savings rates. Like anywhere, most savings are done in the local currency; with higher savings the local currency improves.
  • Pictet Long-term CHF real effective exchange rate

    click to expand

    Swiss wealth has spread far beyond the top 1%. Swiss diversify their wealth in different types of assets. Due to low interest rates and for tax reasons, mortgages are often not paid back quickly – “the bank still owns the house.” The well-diversified assets are far higher than this debt.

  • As opposed to other countries, Swiss wealth improved not only via the artificial accounting entry called “home price” that is inflated everywhere by central banks, but by the far more tangible value “Net International Investment Position“.
  • The ever appreciating currency is a “self fulfilling prophecy”: the Swiss tend to invest in local currency or to hedge foreign currency exposure (an example for a recently offered fund hedged against CHF appreciation). Americans often buy foreign stocks without hedging the currency risk against USD.
  • Structural arguments: 
    • Low Swiss taxes, efficient administration, low debt.
    • Small Swiss distances and low spending on energy compared to the U.S.: Until the 1960s and in the 1980s oil was cheap and the United States could expand well. In the future,  the U.S. may always have high (oil) trade deficits and therefore higher inflation.
    • This results in positive Swiss real wage growth.  In America you see the different movement: in particular due to rising prices of (imported) oil, real wage growth in the U.S. is negative.
    • Even more, the Arabs or Russians that profit on rising oil prices often bring their wealth to Switzerland to safeguard it from their governments. This boosts the Swiss banking business and the whole economy.

Question 2) Do you see EUR/CHF appreciate? When you trade currencies, you should always know that you trade (relative) inflation and (relative) interest rates. Thanks to cheaper imports after years of currency appreciation, the Swiss CPI has not yet reached the yearly wage growth rate of 0.7%, but will approach it sooner or later. In 2011/2012 European leaders introduced austerity and supply-side reforms. Together with high unemployment, this exercises pressure on wage growth in Europe as a whole. Inflation came down, the Spanish or Italian producer price index fell from over 3% YoY in mid 2012 into negative territory in 2013/2014. Thanks to this disinflation the EUR/CHF floor was not in danger any more. In 2013, currencies with higher inflation and wage growth like the US dollar, the Norwegian Krone or the Australian dollar fell in value against the euro.

Hence I’m of the opinion that Draghi’s “whatever it takes” was nearly irrelevant, but “conditionality” was the key for the European success story.

American and German wages are currently rising by around 2% per year. This is the CPI number those two countries might adopt over the longer term. Due to the American oil dependency mentioned above, German inflation should be a bit lower, the U.S. CPI a bit higher than 2%. Swiss wages should continue to rise by 1%: this rate might accelerate in some years.

I strongly doubt that peripheral and French wages will match the 2% German salary increases in the future. Their unit labor costs had risen by around 25% compared to Germany between 1999 and 2008.

European spending and inflation will remain subdued. The ECB will not hike rates for years, maybe for a decade. Therefore a EUR carry trade against CHF is impossible – but the opposite, a CHF carry trade against EUR, could happen in some years.

Question 3) I would like to learn more on your thoughts on CHF interest rates?

Short-term rates are determined by wage growth and inflation. Due to the nearly booming Swiss economy and the recent Swiss referendum that limits immigration, I reckon that future Swiss wage increases will be higher than the ones in France or Southern Europe. Certainly Swiss inflation is limited by the structural arguments mentioned above, but this is not enough. On the other side, German and Northern and Eastern European wages will rise more than Swiss wages. Therefore the Swiss YoY CPI should be more or less identical to the euro zone CPI from 2015 or 2016 on.

Once global inflation accelerates, I see Swiss home prices increasing more strongly again. Swiss homes act as an inflation hedge not only for the Swiss but for safety-seeking wealthy investors worldwide.

At that moment, the SNB might be forced to hike rates well before the ECB.

  Question 4) Especially short term money market rates which are negative.

Currently only the SARON, the Swiss money market rate for overnight deposits is negative. It stands at -0.04% as opposed to +0.043% for the EONIA, the one for the euro zone. Swiss banks are ready to pay negative rates, because they have abundant liquidity. They do not offer EUR lending despite interest rate differentials. This has four main reasons: 1. The currency risk: namely that CHF appreciates more than the 0.08% during the lending period. See the arguments above. 2. They would lose risk-weighted assets (RWA) when they lend against less safe commercial banks instead against a central bank – the SNB. If they do so they have issues in fulfilling the leverage ratios given by the Swiss regulators. 3. There is no demand of EUR liquidity, because banks’ liquidity is already abundant in the euro zone. The problem is that there are not enough private-sector borrowers. Due to low growth expectations demand for credit has fallen, but supply is already enough. (See Buba’s Weidmann who says the same.) 4. Transaction costs may be close to 0.08% per year.     Question 5)  How long do you believe the negative rate pressures will continue?

As long as global inflation does not take off, negative rate pressure will continue. Still the Swiss CPI should move more and more toward the 0.7% wage growth rate. Both wages and inflation could stabilize between 1% and 1.5% thereafter, provided that the global economy recovers.

Moreover, Swiss banks are lending quite strongly, M3 is increasing by 7.7% per year. This money inflation must end up in price inflation one day, even if weak money and price growth in Europe is able to dampen Swiss price inflation.

While a higher CPI should raise the money market rate a bit, higher lending should reduce excess liquidity. M0 as an indicator of excess liquidity has fallen in recent months, while M1 as an indicator of the use of liquidity has risen. Yes, the money multiplier is rising again in Switzerland, while it is still falling in the eurozone.

  Question 6) Negative rates and banks excess reserves: Does the SNB’s sight deposit facility allow banks to hold unlimited about of excess reserves or are they limited by a cap?

As for any other central bank, there is no limit for excess reserves. Introducing a cap on excess reserves or negative rates is counter-productive for the SNB for the following reasons:

  • These excess reserves are the means of financing the SNB currency reserves. If banks remove the excess reserves (debt on the SNB balance sheet) then the SNB has to cut the branch it is sitting on. It must sell its euros and dollars (assets on the balance sheet). At least over the longer term, this will be a null-sum-game for the CHF exchange rate.
  • The combination of a weaker CHF, rising wages and less labor supply due to the referendum may result into a wage-price spiral. Such a spiral could wreck the Swiss housing market like it did in the 1990s. Already Q1 GDP grew mostly thanks to real estate investments, a potential wrong allocation due to excessive low interest rates.
  • We have seen that 90% of German TARGET2 surplus have ended up in cash under German mattresses or in vaults. Keeping Swiss francs in cash is a lot easier. The highest denomination is 1’000 francs, the risk of keeping cash at home is lower and more common, even compared to Germany. Swiss banks and special companies provide easy-to-use cash storages. Moreover, more cash favors money laundering, something what Swiss regulators are combating.

Question 7) Do you think that the SNB minimum euro exchange rate policy was successful?

In September 2011, the EUR/CHF floor was born based on the wrong assumption that Switzerland could go for longer lasting deflation and the global economy into a recession. The SNB continued to sustain and to incite bank research that published two misleading ideas:

1) “The Swiss franc is overvalued at real effective exchange rate REER values of 110%.” We argue that the REER is misleading, in particular because of rising current account surpluses and strong immigration of highly qualified people in the last 15 years.

2) “The Swiss franc is a safe-haven. Once the crisis is finished, it will devalue.” SNB’s own research has proven that this is wrong, too. As opposed to “real safe havens” like USD and JPY – CHF is rather a “safe proxy for global growth.”

Portfolio Investments in Switzerland

source SNB

In May 2012 Swiss Q1 GDP was released and, thanks to US, Chinese and global growth, Swiss GDP clearly outpaced expectations. At that moment the two wrong assumptions above turned into a blunt lie. The SNB bluff was quickly called by former UBS chairman Oswald Gruebel. Investors piled massively into the Swiss franc. Balance of Payments data published by the SNB itself showed that a big part of foreign inflows were risk-on investments (see graph). In 2011 and 2012, foreigners sold Swiss bonds.

Equity investors are very sensitive to exchange rates that make stocks of overvalued currencies relatively expensive and they sell them.

Hence, If the minimum rate had been defined at (for CHF) overvalued levels of 1.10, then the SNB balance sheet would be 30-50% smaller. If the EUR/CHF floor had been established at parity, then the SNB would have sold off nearly all reserves and the EUR/CHF might be back at 1.05 or 1.10. The choice of 1.20 as the floor was wrong. Together with excessively cheap money, this will turn into a boom with wrong investments.

Question 8) Do you think that the SNB will be as successful in the future as in the past?

The fight against markets was easy until now. The only task was to print enough money to maintain EUR/CHF around 1.20. Thanks to European disinflation, this phase has taken longer than expected and might go for another two or three years.

Somewhere in the future, the SNB will have another enemy, and this one is the most dangerous one. This enemy is called the “Swiss National Bank,” a central bank with the most hawkish monetary mandate, namely inflation under 2% and not like the ECB or Fed close to 2%.

  George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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Target2 Balances and SNB Currency Reserves. They are Both the Same Concept

We show that Target2 imbalances and the SNB currency reserves represent the same issues, namely current account surpluses/deficits and capital flight. Therefore it makes sense to compare them, in total and by inhabitant.

 

In a recent post we explained that currency reserves represent the cumulated balance of payment surpluses over the years, in particularly the cumulated account surpluses and the cumulated capital account surplus.

Important!

Not corrected Balance of Payments (BOP)  = Current account balance + Capital account balance (excluding reserve assets) 

Important!

BOP = Change in reserve assets

Similarly, the Target 2 (im-) balances reflect these two aspects, namely:

  1. Current account surpluses and deficits – vigorously defended by Hans Werner Sinn and many German economists. They claim that the current account imbalances need to be reduced, so that the periphery no longer lives “on the costs of Germany”.
  2. Change in capital account or the “capital flight” – fiercefully defended by Paul de Grauwe, Willem Buiter and Karl Whelan, et. al. They insist that the weak countries must continue consumption and generate growth. With growth the capital flight and consequently the Target2 imbalances will be reduced.

 

These two fractions fought big battles in the financial and academic press, wrote long and complicated articles (see links associated with the names above), in our eyes it was a purely academic fight. Maybe they should have simply said that the first group were “Current Accountist” and the second one were “Capital Flightests“. And that they want to start reducing the (im)balances of payments reflected in Target2 either with the first or with the second methods.

The current solution to the euro zone crisis is the first, the German solution or the Merkel compromise, namely that the weak countries need to implement austerity and increase competitiveness so that they can reduce their current account deficit. This has been successful so far: Italy even has a current account surplus, Spain and Greece reduced their deficit. And, oh wonder, the capital flight and target imbalances were reduced and money came back to the periphery. Still De Grauwe and Whelan will claim that austerity will trigger lower growth over many years and weaken the countries’ finances over the long-term.

In the following graphs we want to now present the link between the reserves of the Swiss National Bank (SNB) and the Target2 (im)balances, which, as we have learned now, are essentially the same.

For the SNB, however, and this is strange, the reduction of Target2 balances did not imply a reduction of currency reserves: the capital flight from Spain to Germany was reversed, but not the capital flight into Switzerland (or that the Swiss current account surplus was higher than the capital account outflows).

We give some hints, the gap between the latest movements in Target2 balances and SNB reserves, has to do with a capital movements of “positive animal spirits” that want  higher investment yields (e.g. asset prices in Switzerland are rising, but falling in the periphery) and “negative animal spirits” that just want to preserve their money against a euro zone collapse.

Target2 Balances vs. SNB Reserves

(click to expand), Target2 Balances in Mil. € vs. SNB reserves (data sources University Osnabrück and SNB IMF data)

 

Hence, the Swiss occupy the second position with 400 billion € reserves, whereas Germany has a Target2 surplus of 700 billion € inside the so-called “euro system”. That Greece, Spain or Ireland have deeply negative Target2 balances means that their central bank would have deeply negative equity and their country would be probably bankrupt, if there were not the euro system that keeps them together.

Representing this on a per person level, we obtain the following graph.

Target2 vs. SNB Reserves per Inhabitant

(click to expand), Target2 Balances vs. SNB Reserves per Inhabitant (same sources as above)

Apart from Luxembourg (see below), the Swiss possess the biggest “imbalances” with 51400 € per person, while Germany has a surplus of 8721 € and Finland 9595 €.

We imagine now that one day the euro zone breaks up – maybe not because the periphery goes bankrupt as suspected between 2011 and 2012, but because German,  Finnish (and also Swiss) inflation gets far higher than inflation in the periphery, but Mr Draghi does not want to hike rates. (The latest German CPI MoM change was +0.9% !).

Or because Mr Berlusconi wants Draghi to lower rates and if not, then Italy leaves the euro zone. In case of a break-up, we suggest an exchange rate difference of 20%  between the North and the South and the Bundesbank and other Northern central bank lose 20% of the value of its assets. At the same time, the EUR/CHF exchange rate drops by 20%.

20% loss/win per inhabitant in € in case of euro break-up or 20% EUR/CHF devaluation

20% loss/win per inhabitant in € in case of euro break-up with 20% haircut or 20% EUR/CHF devaluation

 

While for the German tax payer, the euro break-up would be relatively cheap with 6’977 € per inhabitant, it would be very expensive for the Swiss: they would need to pay 41’120 € each.

The Luxembourg case

It is well known that Jean-Claude Juncker, the former Luxembourg prime minister, is maybe the biggest euro guardian claiming regularly that Germany must bail out the European periphery. We know why: Luxembourg has a Target2 balance of 210’802 € per inhabitant and would suffer a loss per person of 168’642 € in the case of a euro zone breakup. The numbers of  Luxembourg, that possesses a big private banking center, were that big that they did not fit into our graph.

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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SNB Remains the Only Central Bank Currency Warrior: The Japanese do not Fight, they Talk

Currency WarriorsCentral Bank data shows that the Swiss National Bank (SNB) remains the only central bank that strongly participated in currency wars with Foreign Exchange interventions, while such “physical” interventions by the Bank of Japan remain very limited. The recent Japanese FX interventions were purely verbal, while hedge funds and FX traders warriors acted on behalf of the Japanese on the FX battle field.

SNB Balance sheet vs. the Bank of Japan’s one

This is the latest SNB balance compared the one of the Bank of Japan. The latest SNB balance sheet can be obtained here on the SNB site.

 

The following is the SNB balance sheet as of December 2011, compared to the BoJ before the latest monetary easing program (as of September 30, 2012).

SNB Balance Sheet Dec 11 vs. BoJ Sep 12

(click to expand), sources (SNB monthly bulletins and BoJ)

 

The data shows that prime minister Shinzo Abe, his Ministry of Finance (MoF) and its “department”, the Bank of Japan (BoJ), were just generals and commanders that directed verbally. Different American hedge funds and FX traders fought in the name of the sacred Japanese matter; they were the currency warriors, while the MoF preferred not to soil their hands with foreign assets. None-withstanding private Japanese investors possibly continued to buy US treasuries.

We attributed the behaviour of traders to sharply reduced risk aversion and a potential new boom of U.S. housing.

Effectively the BoJ balance sheet for February 20th, 2013 shows that the share of Japanese government bonds (JGBs) and Discounted Japanese Treasury Bills compared to the total balance sheet rose from 68.6% to 74.7% since the end  of September, while assets in foreign currency remained stable at 3.1%.

The SNB, however, holds foreign reserves for 86.5% of its balance sheet. This balance makes up 83.2% of Swiss GDP, up from 57.7% in 2011. The BoJ balance sheet amounts to 31.7% of Japanese GDP. This percentage has risen only slightly since September.

 

While the Japanese surplus is slowly shrinking (and not quickly like Kyle Bass might suggest), the Swiss have increased their current account surplus thanks to the depreciation stopped appreciation of their currency. The EUR/CHF 1.20 level was comfortable enough for Swiss companies to increase the surplus in 2012: it rose to 74 bln. CHF or 12% of GDP in the last 4 quarters (Q4/2011 to Q3/2012), while the sharp rise of the franc caused it to shrink from 82 bln francs in 2010 (14% of GDP) to 50 bln. (8%) in 2011.

And oh wonder, a strengthening of the Swiss current account surplus bizarrely coincides with the key tasks of the SNB, namely price stability taking into account economic developments – the external component is still a part of GDP.

Mr Jordan explicitly denies that the current account surplus is important to the SNB. But he clarifies that the Swiss current account is strongly driven by global growth.

Deliberately he has left out the 12% of GDP current account surplus for 2012 in his latest marketing event for the Swiss market manipulation. Instead he gives excuses that 40% of the shares of Swiss multi-national companies are held by foreigners and that the balance of payments (BoP) only mirrors outflows in the form of dividends to these foreign investors but not stock price gains. Moreover he claims that Swiss shopping in neighbour countries were a big source of errors for the BoP.

 

Real Effective CHF and Current Account

Real Effective CHF Exchange Rate and Current Account Surplus

 

FX traders will have little chance to stop a sharp Swiss franc revaluation caused by SNB franc buying when one day growing Swiss surpluses, wealth and home prices drive Swiss inflation towards the SNB price stability target of 2%.

 

The BoJ possesses FX reserves for the equivalent of the Japanese current account surplus of one year, while the SNB has foreign assets for nearly 6 years of current account surpluses in her books. This difference shows again that the Japanese are no real currency manipulators, but the Swiss are.

Read why Swiss investors might require a sufficiently big gap between global and Swiss yield of return in order to invest in foreign assets again:  Is the Swiss Capital Account Able to Neutralise the Persistent Current Account Surpluses?

 

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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A Nationalization of Swiss Foreign Assets? SNB Owns 56% of Swiss Net International Investment Position

 

By early 2013, the SNB held 56% of the Swiss net international investment position (“NIIP”), but in the year 2007 this number was only 12%. Is the central bank implicitly nationalizing the Swiss international companies? Or is rather a form of de-nationalizing the Swiss public, given that the stock owners of Swiss multi-nationals are more and more foreigners and less Swiss?

Net International Investment Position Switzerland Portfolio Investments Foreign Direct Investments Loans

 

Update September 2014:
In 2013 and 2014 the size of SNB balance sheet remained constant but the Swiss as a whole improved their investment position. Therefore the ratio should have fallen a bit.

More insights:

  • Probably it is not a nationalization but rather a transfer from the Swiss tax payer to the Swiss multinationals and to their share holders, who happen to be foreigners more and more. This in case that EUR/CHF falls under 1.20, the SNB will have losses, the firms continuing profits. Or maybe a genius strike if the euro remains above 1.20 forever….
  • Net Direct Investments Rising: Swiss multinationals are profitable despite the stronger franc. By nature, direct investments yield fairly more than portfolio investments.
  • Foreign reserves are just portfolio investments, done by a national entity. Often they are invested in a more conservative manner than typical portfolio management. Both China and Singapore have state funds that invest more in equities, recently the SNB increased the equities share to 15%.
  • Net Portfolio Investments Shrink: Foreigners are buying more Swiss equities than Swiss purchase foreign equities. By far the biggest part of Swiss portfolio investments (both inbound and outbound) are equities, far less are fixed income.
  • The rise of the Swiss franc has nothing to do with hedge funds or speculators. Most foreign investors are long-time investors that bought Swiss equities.
  • Net Loans are negative and were falling: Net Swiss Borrowing is heavily increasing. It is the traditional two-step  banking model: Wealthy (foreign and local) clients lend to Swiss banks, Swiss banks lend to Swiss consumers and firms via mortgages / other loans.
  • The SNB must counter three effects if she wants to maintain the 1.20 EUR/CHF:
    • Someone must restrict the success and the high profits of Swiss multinationals: This sounds like a joke, but the Swiss left is preparing a so-called “1:12 wage initiative”  This referendum initiative wants to limits top salaries to 12 times the lowest salary. Glencore might leave Switzerland if the referendum passes. An exit of a multinational from Switzerland would weaken the future NIIP growth, but reduce the implicit transfers from the tax payer to these companies.
    • She must buy more foreign equities or bonds (if the latter yielded enough…) than foreigners buy “net” Swiss equities.
    • The most difficult task, however, is to stop the (net) lending to Switzerland and in the long haul inflation. The latest monetary policy assessment has shown that the bank is very nervous.

     

  • In summary, the SNB is getting into a similar situation as China, where the state owns 300% of the NIIP.  Already the number of 56% is most astonishing for a developed economy like Switzerland.
    On most of the reserves, i.e. US Treasuries, China earns very poor income, but foreign companies earn a lot more on inward direct investments (FDI), e.g. Americans 33% in 2008.The Chinese decision to quickly strengthen the Renmimbi was probably a good choice.

The difference between China and Switzerland is the following:

China runs current account surpluses of only 2-3% of GDP, outwards FDI and portfolio investments are rising. The profitability of inwards FDI has fallen because salaries have heavily increased.

The biggest part of the 14% Swiss  current account surplus are profits in trade of goods and services, implicitly profits of Swiss firms. With continuing profits, however, the inflow of portfolio investments to Switzerland, purchases of Swiss equities by foreigners, should not stop.

Are Swiss investors able to achieve higher foreign yields than the yield on Swiss investments?

In order to weaken the Swiss franc, capital outflows must counter the continuing Swiss current account surpluses. The essential question herewith is : “is the yield Swiss investors are able to achieve abroad considerably higher than the yield received at home (or paid if the franc is used for leveraging)?”

The first thing we need to remember are global growth expectations: while until 2007 the franc was used as a funding currency for investments in foreign assets a big difference of 3 – 4% GDP growth between Swiss and the global economy persisted. However, the expected Swiss growth rate of around 1% in 2012 and 2013 (source UBS) is only a bit lower than global growth of 2.5%. Investments in Swiss real estate have achieved 5% per year since 2008.

Prices for owner-occupied apartments have risen 5% a year on average since 2008, with rises of 6.2% in Zurich and 8% in Geneva.   source WSJ

Especially for Swiss foreign portfolio investments, the question arises if these foreign investments are justified in a risk-return perspective, given that higher foreign growth will be obtained in emerging and less developed countries with substantial political risks and downside risks in the case of a recession.

Slowing Global Growth 2007-2012

 

See full details in Is the Swiss Capital Account Able to Neutralise the Persistent Current Account Surpluses?

Read also: The Swiss Balance of Payments, 2012 and History

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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Why the SNB will not Imitate Hong Kong, but Potentially Singapore

The SNB will not be able to realize a fixed currency peg against the euro over the long-term. One example of a fixed peg is Hong Kong. This country has a so-called “currency board” against the US dollar. The exchange rate between the US dollar and Hong Kong dollar is fixed. Hong Kong has managed to maintain this peg for years, even if recently it was under pressure.

 

USD/HKD since 1999

USD/HKD since 1999

 

Switzerland cannot imitate Hong Kong for the following reasons:

  • Taxes: Having a real estate tax only for foreigners like in Hong Kong will not help.  It is incompatible with the Swiss-EU bilateral agreements and can be circumvented quite easily. A citizen of the EU could rent a flat for a small period and is an official resident of Switzerland. He is allowed to buy a home. In order to change this, Switzerland would need to exit from the bilateral agreements.
  • The currency reserves of Hong Kong did not rise that much unlike the Swiss did. They have increased by 10% since 2011, but the ones for the SNB by 50%.
  • Swiss Bubble Index Q3 2013 UBSHong Kong’s real estate market seems to be clearly overvalued. But in Switzerland it is only situated in the initial risk phase. Switzerland seems to be able to attract foreign capital to be invested in real estate, with the long-term result that inflation goes up.
  • Hong Kong does not have big safe haven attractiveness like Switzerland, because it is dominated by the authoritarian state China.
  • The main important point is the following: Currency boards make sense for countries that have higher inflation than the target country.  In 1997 Bulgaria introduced a currency board against the ECU/Euro, a region with lower inflation and Hong Kong one against the US dollar. Jim Rogers said recently that he cannot imagine Switzerland becoming a “new Bulgaria”. The consequence would be similarly to Bulgaria: Switzerland would have at least the same inflation and the same interest rates as the euro zone. This would make Switzerland less attractive for investors and weaken Swiss banks, as Oswald Grübel already said last year.  Like Thomas Jordan asserted in 1999, over the long-term Swiss companies would need to borrow at a higher rate and lose their competitive advantage.
  • Because of this difference, the peg of the HK dollar against the US dollar may remain for years but the EUR/CHF peg cannot. Hong Kong still has smaller wages than the United States; therefore, it is able to counter higher wage and inflation increases with a rise in productivity. Similarly, Bulgaria has far smaller wages than the eurozone.
  • Switzerland, however, has higher wages and higher productivity thanks to big structural advantages, lower taxes and sees immigration of highly qualified personnel from the euro zone. The European periphery needs to reduce wages to become competitive again. Therefore inflation in Switzerland could be bigger than in these European countries, once the deflationary effects of the “strong franc” have washed out.
  • If the floor is maintained, then the Swiss might obtain a similar inflation rate as Germany (currently 2.1%) over the long-term; their inflation baskets are quite similar. Whereas German salaries are poised to rise more quickly than the Swiss ones, monetary expansion and increase of real estate prices are far higher in Switzerland. Since the Swiss seem to be less reluctant to spend (see here and here) than the Germans, it is possible that in a  couple of years Swiss inflation will be higher than in Germany.

 

We think that the SNB will exit the peg in one to three years. When depends on the state of the global economy, the more the global economy improves, the earlier it happens because Switzerland will exhibit higher inflation. If the United States leads the global recovery, then the EUR/CHF rate could remain above 1.20 for some time.

Both countries, Switzerland and maybe one day even Hong Kong will imitate Singapore, that follows a so-called “basket, band and crawl managed float (BBC float)”.

The Singapore dollar is managed against an undisclosed basket of currencies of its main trading partners and competitors. The exchange rate floats within a set policy band, which lets the currency crawl up or down instead of being subject to sharp fluctuations. The Monetary Authority of Singapore (MAS) has said the BBC policy has given it flexibility in responding to changes in both local and global conditions to maintain export competitiveness and control inflation.  source

Similarly to the People’s Bank of China (PBoC), the MAS increases its reserves during  “currency reserve accumulation phases” thanks to current account surpluses and capital inflows.

Singapore Currency Reserves vs. USD/SGD

Singapore Currency Reserves vs. USD/SGD

Both the MAS and the PBoC combat wage increases and internal inflation with a controlled appreciation of their currency (the currency “crawls up”). In order to do this, they sell foreign currency reserves and realize FX losses. During weak economic phases – the last long one during the Asia crisis in 1998 – they might also allow the currency to “crawl down” and they realize FX gains.

Given that weak phases do not happen very often – these central banks must obtain sufficient profit during the “currency reserve accumulation phases” with income and valuation gains on their assets. In order to improve profits the MAS possesses a Sovereign Wealth Fund (SWF): the Government of Singapore Investment Corporation (GIC) manages 100 billion dollars, 30% of the Singaporean reserves. An SWF is a model that had been excluded by the SNB till now. The Chinese SWF, called “China Investment Company, CIC”, looks after 12% of the total Chinese reserves of 3.3 billion dollars and goes more risks than the State Administration of Foreign Assets (“SAFE”), that essentially holds government bonds.  The SNB has increased the equity quota to 12% in the third quarter 2012. As opposed to an SWF, the Swiss follow a passive investment strategy.

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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SNB’s Jordan Responds to the Critique from the Peterson Institute: What They Forgot to Ask Him …

 

Last year, Joseph Gagnon from the very influential Peterson Institute criticized the Swiss National Bank (SNB) saying that they manipulate currency exchange rates and implicitly harm the recovery of the United States (link to his paper).

In August 2013, SNB chairman Thomas Jordan has finally come to Washington to respond to this critique in one of the most important speeches in his career: “Making Monetary Policy for Switzerland in a Global Economy”, Peterson Institute Washington D.C.

The transcript of the speech is available at the SNB website.

Jordan’s main arguments are that:

The Swiss current account surplus is due to very specific factors. The goods trade account, for instance, makes only a modest contribution. The three most important elements with regard to the current account surplus are investment income from Switzerland’s substantial net international investment position; financial sector earnings from business with customers abroad, which is traditionally a significant source of revenue for Switzerland; and earnings from merchanting, which have risen sharply over the past decade….

SNB monetary policy is focused on ensuring price stability, while taking due account of economic developments. To fulfil this mandate, the SNB must secure appropriate monetary conditions. The current account surplus does not play a role in monetary policy.  source SNB

According to the transcript, the real trade-weighted exchange rate shows an overvaluation against 1999 of only 7%, after reaching 24% in August 2011.1

Real Effective Exchange Rate CHF October 2013

Jordan’s arguments and  the Q&A are here, we  recommend the audio that has a better quality than the video above and is always available.

Joe Gagnon asked an interesting question in the Q&A , listen to the Q&A audio at around 10 minutes.

To give the readers some more possibilities to draw their own conclusions, here are the comparisons among SNB reserves, trade surplus in goods and services and the incomes on foreign investments.

SNB Reserves vs. Current Account Trade

click on graph to expand, data source SNB IMF data

 

 What Adam Posen, Joe Gagnon and the Peterson Institute Forgot to Ask…

 

  1. Mr Jordan, you are saying that Switzerland could have entered, and might still enter, a deflationary trap if you gave up the CHF cap. Are there really deflationary risks given that nominal wages appreciated by 0.8% per year2, that rents are risings by 0.9% 3, wealth increased by 4.5%4 and consumer spending by 2.5% annualized5?
  2. According to today’s Swiss CPI figures, prices of private services increased by 0.7% y/y, prices of public services by 1.1% and the ones of goods produced in Switzerland by 0.7% y/y. Only imported goods like clothes, household equipment and energy still exercise deflationary pressure, but could be washed out after some time.
    Is the minimum exchange rate still justified under the “deflationary trap criterion”?
  3. The difference between inflation in the euro zone and in Switzerland has narrowed to less than 1%, when measured in HICP terms. The low euro zone inflation rate is driven by very weak demand, especially from Southern Europe, somewhat intensified by the wish of European leaders to lower labor costs there. With falling wages and demand Greece seems far closer to a deflationary trap than Switzerland.
    Italy has an inflation rate of 1%, just slightly higher than the price increases of Swiss services. Couldn’t a stronger franc help boost Swiss purchasing power and Swiss consumer demand for products from (or travel to) Southern Europe?
  4. You mentioned the strong Swiss net international investment position (NIIP) that is mostly made up of Swiss international companies. Are you aware that SNB reserves are the equivalent of 56% of the NIIP and that the SNB effectively owns far more than these companies?
    This is a similar situation as for the People’s Bank of China, implying (for both countries) that further currency appreciation means losses for the central bank, while companies take profit on the weaker currency?
  5. You said that Swiss exports are mostly unrelated to the exchange rate. But sudden exchange rate fluctuations would harm the export industry. The EUR/CHF has barely changed since the end of December 2010, when it was around 1.24.
    Why don’t you move the EUR/CHF minimum exchange rate to 1.15, this would be a relatively small change that does not harm exporters?
  6. Switzerland has two types of exporters: for pharmaceuticals, chemicals, watches and the luxury industry the exchange rate does not matter a lot, while the machinery industry has struggled. Is the minimum exchange rate not an artificial subvention for a certain industry? Should Switzerland not concentrate on the industries where it has a comparative (Ricardian) advantage?

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
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References
  1. For insiders: 1999 was 3 years after the bust of the Swiss real estate bubble, a quite difficult time for Switzerland. []
  2. source Swiss statistics []
  3. source Swiss statistics []
  4. source SNB []
  5. source SECO []

Weekly Monetary Data: History of Sight Deposits at SNB

The financing of SNB currency reserve purchases is currently realized using the funding local and international banks and companies provide and deposit at the SNB. This electronic transfer is commonly called “money printing” because it replaces the printing of paper money. Sight deposits are implicit loans from banks and companies to the SNB – currently honoured by 0% interest. Total sight deposits have increased to a total of 375 billion francs from 220 bln. at the beginning of 2012 and 28 bln still in 2011.
Together with around 60 billion of bank notes, the sight deposits provided by Swiss banks build up the so-called “central bank money” or “monetary base” M0. This central bank money M0 is combined with other (non-Swiss bank) sight deposits and around  60 billion SNB owners’ equity to obtain the total of 495 bln. SNB Liabilities, the means of financing the total of 495 billion SNB reserves, its assets.
This is the first way of looking at it: The SNB prints more money, increases its debt, in order to buy more foreign reserves and to keep the EUR above 1.20.
There is a second way of looking at it, it represents somehow an opposite explanation: The Swiss do not know how to invest their money obtained by trade surpluses. Foreigners that seek safe-havens have the same problem. Instead of investing money abroad they leave the funds on their Swiss bank account.
By simple balance sheet logic, the Swiss bank needs to book an asset for the obtained cash liability to the client. The bank could decide to create a big cash vault or it could lend the funds to somebody. In this case, the Swiss bank does not want to take risks neither: it does not risk to lend neither in CHF, e.g. for Swiss mortgages or to lend in foreign currency, e.g. to a foreign bank in the weak euro members. As opposed to lending, funds at the central bank neither weaken the Basel 3 ratios nor require additional counter-cyclical capital. It also opts against a big cash vault because it would have costs of maybe 0.1% of the total. (In the Swiss case there is a big economies of scale effect). Instead the bank deposits the funds at the central bank as an (electronic) CHF sight deposit. Despite many francs ending up at the SNB, CHF lending for mortgages has heavily increased.
If the CHF exchange rate could freely float then sight deposits at the SNB would not increase, but the FX rate would adjust until there is less desire to hold CHF deposits. With a stronger CHF it would make more and more sense to buy foreign assets because those assets would become cheaper in CHF. Some critics (e.g. here at Inside Paradeplatz) say that the SNB weakens the Swiss economy, because it buys foreign assets. This is not true, because the SNB makes Swiss investments like houses and stocks but also loans cheaper than they would be in a free market, simply because CHF is cheap for foreigners. It fuels the housing bubble.
The weekly monetary data on the SNB website shows the change in sight deposits; page 3 of this post contains the detailed overview of the weekly change since the beginning of 2012.
The weekly monetary data gives an far earlier indication of changes in sight deposits than the relatively late releases of SNB balance sheet data.

Latest Data:

The following data come from the SNB balance sheet and from the weekly sight deposits release.

Sight Deposits of Swiss banks (part of M0)

With the economic recovery in the U.S. and lower risks, Swiss banks have reduced their sight deposits somewhat and possibly started more lending. This, however, stopped in summer.

September 26: 310 bln. CHF
August 2014: 314 bln.
July 2014: 307 bln
Q2/2014: 302 bln.
May 2014: 304 bln.
Q1/2014: 316 bln.
Record high in June 2013: 321 bln. CHF

“Other Sight Deposits” of counter-parties with an account at the SNB (not included in M0 !).
These counter-parties are insurances, pension funds, investment companies and foreign banks and institutions. They are not part of M0, because they are not able to “multiple money” with loans to the public.

September 26: 46 bln. CHF
August 2014: 45 bln. CHF (of which 12.7 foreign institutions)
July 2014:  50 bln. CHF (of which 14.8 foreign institutions)
Q2/2014: 50 bln. CHF (of which 15.4 foreign)
May 2014: 51 bln.  (of which 17 bln. foreign)
Q1/2014: 48 bln. CHF (of which 14.5 bln. foreign)
Q4/2013: 36 bln. (of which 10.5 bln foreign)

The weekly monetary data also contains the loans from the Swiss federation,currently about 12 bln. CHF, they are not part of M0 neither.

In the balance sheet the “other sight deposits” of the weekly monetary data are split into more details:

  • foreign banks and institutions are shown separately.
  • loans from the Swiss Federation to the SNB and
  • misleadingly again “other sight deposits”. Here these are the ones of insurances, pension funds and investment companies.
Sight Deposits of Swiss banks With the recovery and less risks, Swiss banks have reduced their sight deposits. Together with bank notes this component constitutes money supply M0. They potentially have better ways to use this excess liquidity, like lending more. Q2/2014: 302 bln. CHF 2014/05: 304 bln. Q1/2014: 316 bln. Record high in June 2013: 321 bln. CHF “Other Sight Deposits” of counter-parties with an account at the SNB are increasing, but slowed recently. (For example, insurance, pension funds, investment companies and foreign banks and institutions) Q2/2014: 50 bln. CHF (of which 15 foreign) 2014/05: 51 bln. (of which 17 bln. foreign) Q1/2014: 48 bln. CHF (of which 14.5 bln. foreign) Q4/2013: 36 bln. (of which 10.5 bln foreign)Read more at: http://snbchf.com/snb/composition-reserves-q2-2014/ | SNB & CHF

 

Record High of the total sight deposits (Swiss banks, other sight deposits plus loans from Swiss Federation):

373 bln. CHF in November 2012, compared to 218 bln. CHF still in April 2012 and the record low of 28 bln.

Record Low after the financial crisis:

Only 28 (in words twenty eight) bln. in July 2011,
this was less than values of 65 bln. CHF in August 2009.

In order to prevent inflation, the SNB let the CHF appreciate until Summer 2011. Foreigners piled into Swiss investments and pushed inflation and the Swissie upwards.

With the stronger CHF, foreign investments became cheaper for the Swiss. With rising inflation, holding cash did not make sense any more.
Hence Swiss investors decided to use their cash: consequently sight deposits at the SNB decreased, too.

On the next page some historical headlines and more detailed data.

15 Billion SNB Losses on Gold in 2013, But 40 Billion SNB Profit on Gold between 2000 and 2012

When the Swiss National Bank (SNB) published its preliminary 2013 annual results, it said:

According to provisional calculations, the Swiss National Bank (SNB) will report a loss in the order of CHF 9 billion for the 2013 financial year. Valuation losses on gold holdings amounting to some CHF 15 billion contrast with a gain of around CHF 3 billion on foreign currency positions and ..
more  SNB

If we distinguish between total profit and profit on gold since 2000, we obtain the following:

SNB results vs. gold profit 2013 Since the SNB decided to value gold at market prices in 1999, the total SNB profit over the years has been 32.1 bln. CHF. Gold contribute 24.6 billion and Forex investments 7 bln CHF. Between 2000 and 2012 the profit on gold had been 40 billion francs. Between 2000 and 2007 the bank sold gold for an average CHF 16241 per kilo and realized profit. Most of these gold holdings  were accumulated during decades until the 1970s,most for the official Bretton Woods rate of 35 dollar. By end 2013, the price for a kilo was around CHF 35700. Here a different source for SNB total annual results.

SNB Longterm Results

via Hubon

The SNB claims that – opposed to stocks and bonds – gold has just a cost of carry but no yield. However, the average yearly return of SNB gold positions has been 10.8% since the year 2000. Details:

SNB Risk Return Comparison

(click to expand), major source SNB annual reports, e.g. report 2012 on page 72.

 

Read more on SNB gold sales and the referendum on SNB gold holdings: http://snbchf.com/2013/03/swiss-gold-referendum/

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
----------------------------------------------------------------------------------------------------------------------------

SNB Q2/2014 Composition of Reserves and Balance Sheet

We regularly publish the SNB asset structure by currency, rating & duration, and they might be a template for the tactical asset allocation in these dimensions (CHF certainly excluded) for other fixed income and/or rather conservative asset managers.

Total Balance Sheet and Liabilities

Balance Sheet:
The size of the SNB balance sheet is rising again, after it slowed in Q4/2013.

Q2/2014: 508 bln. CHF
May 2014: 501 bln.
Q1/2014: 495 bln.
Q4/2013: 490 bln.
Q3/2013: 495 bln.
Previous record high in May 2013: 507 bln.

SNB Assets:
— Owner’s Equity:
In Q2/2014, not only did the dollar rise in price – reason Draghi’s downtalk of the euro –  but all other types of assets as well: gold, bonds and equities.

Q2/2014: 64 bln. CHF
Q1/2014: 52.3 bln.
Q4/2013: 48 bln.
Q4/2012: 58 bln.
2009: 66 bln.

more on the invested assets below

SNB Liabilities

— Sight Deposits of Swiss banks

With the recovery and less risks, Swiss banks have reduced their sight deposits. Together with bank notes this component constitutes money supply M0.
They potentially have better ways to use this excess liquidity, like lending more.
Q2/2014: 302 bln. CHF
2014/05: 304 bln.
Q1/2014: 316 bln.
Record high in June 2013: 321 bln. CHF

— “Other Sight Deposits” of counter-parties with an account at the SNB  are increasing, but slowed recently.
(For example, insurance, pension funds, investment companies and foreign banks and institutions)
Q2/2014: 50 bln. CHF (of which 15 foreign)
2014/05: 51 bln.  (of which 17 bln. foreign)
Q1/2014: 48 bln. CHF (of which 14.5 bln. foreign)
Q4/2013: 36 bln. (of which 10.5 bln foreign)

Reference: the latest balance sheet

SNB Investment structure of Assets

As at 31 March 2014, the key asset allocation data for the foreign currency investments and the Swiss franc bond investment portfolio were as follows (figures of previous quarter are indicated in brackets):

Foreign currency investments and Swiss franc bond investments (end of Q2 2014)

Investment structure at the end of Q2 2014

As at 30 June 2014, the key asset allocation data for the foreign currency investments and the Swiss franc bond investment portfolio were as follows (figures of previous quarter are indicated in brackets):

 

Foreign currency investments
CHF bond investments
Currency allocation, excluding investments and liabilities from foreign exchange swaps
CHF
-
-
100%
(100%)
USD
27%
(27%)
-
-
EUR
46%
(47%)
-
-
GBP
7%
(7%)
-
-
JPY
9%
(8%)
-
-
CAD
4%
(4%)
-
-
Other (1)
7%
(7%)
-
-
Investment categories
Investments with banks
0%
(0%)
-
-
Government bonds (2)
73%
(74%)
39%
(37%)
Other bonds (3)
11%
(11%)
61%
(63%)
Equities
16%
(15%)
-
-
Breakdown of fixed income assets (4)
AAA-rated
65%
(66%)
73%
(73%)
AA-rated
27%
(26%)
27%
(27%)
A-rated
3%
(3%)
0%
(0%)
Other
5%
(5%)
0%
(0%)
Investment duration (years)
3.8
(3.7)
6.9
(6.7)

 

(1) Mainly AUD, DKK, KRW, SEK and SGD plus small holdings in additional currencies in the equity portfolios.
(2) Government bonds in their own currencies, deposits with central banks and BIS; in the case of CHF investments, also bonds issued by Swiss cantons and municipalities.
(3) Government bonds in foreign currency, covered bonds, bonds issued by foreign local authorities, supranational organisations, corporate bonds, etc.
(4) Average rating, calculated from the ratings of the three major credit rating agencies.

Equities are managed on a purely passive basis, whereby broad market indices of advanced economies are replicated. Exchange rate and interest rate risks are managed using derivative instruments such as interest rate swaps, interest rate futures, forward foreign exchange transactions and foreign exchange options. In addition, futures on equity indices are used to manage the equity investments.

Source: This page at the SNB shows exactly how the currency reserves are invested.

The investment structure at the year-end is also published in the Annual Report under ‘Asset management’.

Be aware that in the above statistics 17% cash is misleadingly included in the 77% government bonds share (see the footnote 2).

Apart from the increasing value of other currencies, the currency distribution is broadly unchanged against 2012.

In 2012 there were heavy flucations. The SNB bought euros where they were cheap against the dollar, at around $1.25. In August/September 2011, however, they bought USD when the euro was over $1.40.

 

SNB Q1-Q4 Currency Breakdown

Breakdown by major positions

The following gives a rough estimate of major SNB positions (see the European ratings e.g. here), in comparison to all FX reserve positions (of which gold and the smaller IMF, SDR or repos positions are excluded).

  • German and other AAA EUR government bonds make up around 22% of the FX reserves = 48% * 60% * 76%
    Explanation: EUR share 48%, Government bonds 60%, German bonds remain the only major euro-denominated AAA bonds, AAA 76%
    Other AAA are: Dutch, Austrian, Finnish and Luxemburg bonds, all of them smaller countries.
  • US treasuries are around 16% of the FX reserves = 27% * 60% * 100%
    Explanation: USD share 27%, Government bonds 60%, only U.S. issues USD gov. bonds
  • French (and Belgium) government bonds make up around 5.2% of the FX reserves = 48% * 60% * 18%
    Explanation: 48% EUR, Government bonds 60%, AA share 18%, France (and Belgium) are only AA in Europe.
  • Japanese JGB are around 5.4% = 9% * 60% * 100%
    Explanation: JPY share 9%, government bonds 60%, only Japan issues gov. bonds in JPY
  • UK government bonds are around 4.2% of the FX reserves = 7% * 60% * 100%
    Explanation: GBP share 7%, government bonds 60%, only UK issues gov. bonds in GDP
  • Canadian government bonds are around 2.4% of the FX reserves = 4% * 60% * 100%
    Explanation: CAD share 4%, government bonds 60%, only Canada issues gov. bonds in GDP

 

SNB Investment Strategy 2007-2013

Equities, Bonds, Cash, FX, Gold, Swiss National Bank

 

Historic data:

For comparison Q1/2014

Foreign currency investments
CHF bond investments
Currency allocation, excluding investments and liabilities from foreign exchange swaps
 Q2/2014 Q1/
CHF
-
-
100%
(100%)
USD
27%
(27%)
-
-
EUR
47%
(48%)
-
-
GBP
7%
(7%)
-
-
JPY
8%
(8%)
-
-
CAD
4%
(4%)
-
-
Other (1)
7%
(6%)
-
-
Investment categories
Investments with banks
0%
(0%)
-
-
Government bonds (2)
74%
(76%)
37%
(37%)
Other bonds (3)
11%
(8%)
63%
(63%)
Equities
15%
(16%)
-
-
Breakdown of fixed income assets (4)
AAA-rated
66%
(70%)
73%
(74%)
AA-rated
26%
(24%)
27%
(26%)
A-rated
3%
(2%)
0%
(0%)
Other
5%
(4%)
0%
(0%)
Investment duration (years)
3.7
(3.3)
6.7
(6.5)

Find here the information about
SNB Reserve Composition in Q3/2013

SNB Reserves Composition in Q2/2013,
here the one for Q1/2013 and 2012
.

See the historical composition of SNB reserves until 2012 in this post.


George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
----------------------------------------------------------------------------------------------------------------------------

 

SNB has Won the Risk Aversion Battle, When Will the Inflation Battle Start?

With the weakening of emerging markets growth and the strengthening of the United States, the Swiss National Bank (SNB) has won the first battle in the war against financial markets. We judge that until the second battle, the “inflation battle”, starts, some time will pass. Historically, during the inflation battle the Swiss franc appreciates thanks to smaller inflation levels, as compared to the U.S. or Europe.

Update June 2014:

For a longer time the SNB was able to maintain the floor against the EUR. While Swiss wages are still rising by 0.7%, U.S. and German wages are up by more than 2% y/y. The last BEA report even shows 3.6% higher wages annualized. U.S. inflation seems to have started. Costs for U.S. companies are increasing, but not really for Swiss ones. Consequently the CHF is edging up again. Still the U.S. core CPI has risen only to 1.5%, consequently Yellen called the inflation talk “noise”.

 

SNB has Won the Risk Aversion Battle, When Will the Inflation Battle Start?

 

In a September 2012 paper, we stated that SNB requires three preconditions to reduce the high level of currency reserves:

  1. A substantial decrease of risk differentials between the euro zone and Switzerland, i.e. less global risk aversion, lower debt and current account deficits for the weak countries of the euro zone.
  2. Far higher interest rates in the euro zone than in Switzerland.
  3. Stronger GDP growth in the euro zone.

SNB has won the risk aversion battle against markets

Global risk aversion is now substantially reduced, current account deficits have been eliminated for Italy and Spain, and government debt or at least yields have become smaller.

Therefore we judge that the SNB has won the first round in the war against markets, that could be called the “risk aversion battle”. Sight deposits and FX reserves do not increase any more.

 

Bill Gross: U.S. suffers from structural unemployment

In the 1970s the United States saw rising wages for the employed, while many other people were out of work. Some people see similar tendencies now, hourly wages rose by 0.2% in February, finding a job after a good education has become easy. But the participation rate has fallen to 63.5%.

Bill Gross thinks that the Fed will finally target not only a jobless rate of 6.5% but they will target also the participation rate, provided that inflation is not still under 2.5%. He sees low rates for another two or three years.

At the moment when the U.S. really see higher wages and inflation, but high structural unemployment, then the SNB will come into the second type of battle, the “inflation battle”.

The “inflation battle” does not start now

In the inflation battle, gold will follow rises in wages the same as in the 1970s. We judge that the inflation battle will start at the earliest in 3 to 5 years. By then, U.S. rates will be still relatively low, but inflation will be above 2.5%.

By 2013, however, U.S. CPI inflation has come down far under 2%, due to the slowing in emerging markets and falling commodity prices,.

3 Factor Labor CPI

The main Fed gauche, the Core PCE is currently at 1.20%. There is still plenty of time until it will reach 2.5%.

 

What will happen between the “risk aversion battle” and the “inflation battle”?

The euro crisis is not solved.  Problems will intensify, the Southern member states suffer from the same problems as the U.S., but they do not have the privilege to owning a reserve currency. They cannot fight the crisis with higher spending. The ECB’s , the European aid packages and the fiscal compact, do not allow for it. The ECB will not follow the OMT program when conditionality is not fulfilled.

We suspect that global growth will be driven more by the United States, China and Germany (and with it also Switzerland), but a lot less than previously by other emerging markets (see details).

Swiss assets like stocks and real estate will continue to rise, triggering, sooner or later, at least some modest inflation.At the same time, the gap between European inflation figures will become smaller and smaller.

Swiss CPI vs. Eurozone

The SNB has four tasks in the meantime:

  1. Reduce money supply to tame inflation risks in Switzerland.
  2. Reduce risks in the housing sector via the counter-cyclical capital buffer or similar macroprudential measures.
  3. Accumulate income on investments to be prepared for a stronger franc during the inflation battle. See if this is possible.
  4. Sell reserves to limit risks in the inflation battle.

 

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
----------------------------------------------------------------------------------------------------------------------------

Basel III, Swiss Finish and the regulatory minimum capital requirements

The following graph describes the regulatory minimum capital requirements that come in force with Basel III.

Basel 3 Capital Requirements

The following categories are part of the “core Basel III” requirements, to be realized in 2019 globally.

  • Common Equity Tier 1 (CET1), usually ordinary shares.
  • High Tier 1 (HT1), contigency capital (CoCos) that trigger at a higher threshold level of equity to risk-weighted assets (RWA). The capital is converted from debt into equity e.g. at 12%.
  • Additional Tier 1 (AT1), or low tier1, CoCos with a lower threshold, e.g. 10’%. They are hence more secure.
  • Tier 2 capital, subordinated debt, converted into equity at point of non-viability, e.g. 5%. The regulator decides about non-viability.

The following pieces are the so-called Swiss finish, that is purely based on CET1, but not HT1 and AT1.

The Swiss finish is only valid in certain economic conditions and therefore called “macroprudential measures”. They depend on the macro environment, e.g. like currently when interest rates are low and real estate prices and number of mortgages are quickly rising.

Swiss banks are able to raise so much equity only over time:

References:

SNB proposes to raise counter cyclical capital buffer to 2% of CET1.

Presentation from University Zurich, it gives a very good overview of RWA, Basel 3 and Swiss  Finish.

Swiss National Bank: Financial Stability Report, July 2014

FAQ of the Swiss Regulator FINMA on the countercyclical capital buffer.

George Dorgan, snbchf.com

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and we encourage you to complete your own due diligence when making an investment decision. Even if we often write about Forex trading, our advices aren't written for day traders who follow technical channels, but rather for mid- and long-term investors. Our aim is to show discrepancies between fundamental data and current asset valuations, which can lead in mid-term to an inversion to technical channels.
----------------------------------------------------------------------------------------------------------------------------

 

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SNB CHF Blog: A beleaguered central bank in the dangerous world of global macro and euro crisis

SNB CHF Blog: An economic encyclopedia on the Swiss safe-haven and its central bank written by an association of independent financial advisers.

Swiss Price Inflation: HICP: -0.1% y/y CPI 0.0% Avg. Yearly Money Inflation (M3) 8.1% y/y, Avg. Yearly Credit Inflation 3.9%
Other HICPs Y/Y: Eurozone 1.1 0.9, 0.7,0.5 0.4% 0.3%  France: 1.0 0.8 0.8 06 0.5%  0.4% Italy: 1.2 0.8 0.7, 0.5  0.4 0.2 0.1 -0.1%, Spain: 0.5 0.3, 0.2, 0.0 -0.3% Germany:1.4% 1.3% 1.2%1.1%0.6% +0.8% (sources inflation.eu,  Eurostat and investing.com)

Important!

Our Core Thesis: European leaders have successfully implemented austerity, disallowed notorious wage increases in the periphery and nearly introduced deflation. Inflation differences between the euro zone and Switzerland will decrease to zero, Swiss CPI inflation might even be higher in some years. The CHF real eff. FX rate overvaluation talk disregards completely the continuous immigration into Switzerland. Therefore EUR/CHF will remain close to 1.20. Risk-off flows will not leave Switzerland, but they will be converted into risk-on flows (stocks and real estate) thanks to immigration, higher Swiss GDP growth and relatively weak Swiss wage hikes. In particular, in the housing sector these flows will build up wrong resource allocations. In some years stronger global growth and high German wage increases will boost inflation in Germany and partially in Switzerland but Southern Europe will still struggle. By tradition, Germans will move funds into Switzerland in order to protect them from inflation and the ECB. At that moment the SNB will need to hike interest rates - before or in line with the ECB. The Swiss "Soros moment" will arrive and the EUR/CHF will fall under 1.20. The consequence for monetary policy will be:
  1. Either the SNB fights inflation and the Swiss real estate bubble, allows a CHF appreciation and sells reserves below the price of EUR/CHF 1.20 or
  2. Switzerland accepts higher inflation and consequently gives up its competitive advantage in lower inflation and lower borrowing rates. The latter scenario was excluded by the SNB's Thomas Jordan already in 1999 when he pledged against a euro membership. The SNB mandate explicitly disallows inflation.
The first scenario, namely that the SNB sells reserves below EUR/CHF 1.20 is therefore the only feasible solution. Whether the SNB suffers a big loss depends on the income it can generate in the meantime. In regular posts we show how the Swiss CPI comes closer and closer to euro zone inflation. One day, maybe in 10 or 20 years, the Swiss franc will depreciate more strongly, but this will be only after the bust of the Swiss real estate bubble.

 

Permanent link to this article: http://snbchf.com/

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