Friday, January 16, 2015

Swiss policy mistake

The removal of the EURCHF floor by the SNB is a very large policy mistake. Apparently the inflows into the Swiss franc have been too large for the SNB to continue increasing its balance sheet in order to absorb the inflow and keep the floor intact. Moreover, as the ECB will engage in QE next week, the SNB feared that the inflows would even increase further and given the strength of the USD over recent months (which dampens the appreciation of the CHF on a trade-weighted basis) probably thought that it could get out of the minimum exchange rate floor policy relatively easily.
However, what the SNB has done is tighten monetary policy sharply as well as injecting a heavy dose of policy uncertainty into the Swiss economy.
First, inflation has already fallen into negative territory in December amid the fall in oil prices and should have expected to fall further in the short term. Now, however, the SNB has added another sharp deflationary shock for the Swiss economy. In turn, inflation - on the headline and core measures - will fall significantly further. While it has also lowered the 3m Libor target rate as well as the rate charged for deposits held with the SNB from -0.25% to -0.75%, nominal bond yields and mortgage rates are unlikely to fall to the same extent as inflation. Thus, not only has the currency appreciated sharply within a matter of minutes, but also expected real yields have probably risen (unfortunately this is a guess as there are no CHF inflation swaps). While SNB president Jordan stated that the Swiss exporters have had 3.5y of time to adapt to the higher CHF, the new appreciation is very drastic and has never occurred in such a fast period of time. In turn, exporters have just lost 20% in terms of international cost competitiveness overnight, a development which will cause significant pain. Besides exports, also investments should be negatively affected amid the lower exports, the renewed monetary uncertainty as well as the likely higher real yields. In turn, nominal growth - which has already been muted in recent years - will likely turn negative in the quarters ahead.

Trade-weighted Swiss franc shoots to all-time high
 Source: Bloomberg

Moreover, this step is unlikely to end the inflows into the Swiss currency. For one, Switzerland and thus the Swiss franc has likely seen large capital inflows recently not only due to the Euro's renewed weakness but probably even more so due to capital flight out of Russia. Switzerland's safe-haven status, the fact that several Russian oligarchs already operate out of Switzerland and in addition that Switzerland is only half-heartedly following the EU sanctions against Russia should be responsible. The ongoing Ukraine/Russian crisis suggests that these inflows will remain. Moreover, as QE in the Eurozone just gets going, the downward pressure on the Euro will likely remain, not least due to uncertainty with respect to Greek political developments. As a result - and given that the Swiss current account surplus amounts to approx. 10% of GDP - inflows into the Swiss franc and thus appreciation pressure should remain. The negative 0.75% interest rate on SNB deposits is only a weak form to counteract more safe-haven inflows as most of the deposits are not affected anyhow (due to high allowances) and given that 0.75% per year does not seem a lot for those fearing for their wealth. Hence, in order not to see the Swiss franc appreciating much further, the SNB will still be forced to intervene, however, now at lower EURCHF levels and with a much lower institutional credibility. The only alternative to save the Swiss export sector from even more pain might be some kind of capital controls (which would be done by the government). It seems that the SNB did not gain much as it still needs to intervene in large amounts but clearly damaged its credibility and has just forced nominal GDP growth significantly lower.