One of the economic themes of the credit crunch era was established by Brazil’s Finance Minister Guido Mantega who coined the phrase “currency wars” back in September 2010. He was complaining about competitive devaluations which back then were pushing the value of the Brazilian Real higher and it is the effects of a currency appreciation which I wish to consider today. We find quite a few countries experiencing such an event right now around the borders of the Euro as they like planets circling a sun find themselves affected by the gravity of the European Central Bank’s efforts to depreciate its currency. It was only yesterday that I discussed the deteriorating balance of payments problem of the UK and yet the Pound Sterling finds itself at 1.38 which is some 14% higher than a year ago. Hardly a market clearing level for the exchange rate is it as we consider what a “free float” for a currency means right now and as the word free goes into my financial lexicon for these times.
This morning as on so many others the value of the Swiss Franc has pushed higher against the Euro. At just below 1.04 it compares to the just below 1.22 of a year ago back in the days when the Swiss National Bank was capping the rate at 1.20 as described below. From September 6th 2011.
With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.
In fact the SNB had been intervening in substantial amounts in a rather King Canute like fashion for a while as it struggled to control the rise and rise of the Swiss Franc as the “carry trade” blew up. As those who had borrowed in the Swiss Franc looked to buy it back the 1.67 of October 2007 dropped and dropped and the SNB acted because it felt this.
Even at a rate of CHF 1.20 per euro, the Swiss franc is still high and should continue to weaken over time.
Not very good forecasters were there as we see another example of central banking hype leading to a reduction in credibility. Let us look at the consequences.
The opening salvo of the new era included this on January 15th of this year.
The SNB is lowering interest rates significantly to ensure that the discontinuation of the minimum exchange rate does not lead to an inappropriate tightening of monetary conditions.
In fact it cut them to -0.75% and any further strengthening of the Swiss Franc will put further cuts on the agenda. This will be watched closely by Denmark who has also cut to -0.75% and by Governor Carney of the Bank of England. He may have his head in his hands at that point as he considers his posturing that 0.5% interest-rates are a lower bound!
This came from the Swiss Federal Treasury on Wednesday via Reuters.
The Swiss Federal Treasury said it sold 232.501 million Swiss francs ($242 million) of bonds maturing in July 2025 at a yield of -0.055 percent. The bonds carry a 1.5 percent interest rate.
This is an outright first where a national government has issued ten-year debt and investors have paid to receive it. The amount is small at -0.055% per annum but is for each of the ten years. Life could be very different in 3,4, 5 let alone 10 years could it not as I wonder who bought this. Could investors sue for a type of investment negligence? Actually if we consider foreign investors this is quite a clear punt on a Swiss Franc continuing to rise.
Also if you look at the details of the bond it has a coupon of 1.5% so there are very substantial capital losses implied here if the bond is held to maturity. Very odd as tax arrangements usually imply a lower coupon and expected capital gains. Do readers have a view as to why this might be?
Returning to the economics I do not think that pre credit crunch anyone conceived of negative interest-rates going so far along the maturity spectrum. It may yet go further along it as I note that some 34 year bonds were sold at a yield of only 0.42% on the same day.
So much for turning Japanese as over the two lost decades or so Japan has got nowhere near this situation.
Contrasting external and internal monetary policy
This is a struggle which my country the UK has faced many times but Switzerland is seeing it from the other side of the mirror. A bit like the film Doppelganger when Euro-Sec Space Agency Commander Jason Webb crashes his wheelchair into a mirror in an attempt to get to the other side. External monetary policy is contractionary and internal is highly expansionary in an attempt to offset it. What could go wrong?
What about house prices?
This is an issue for Switzerland as it is not long out of a previous boom. From Global Property Guide.
Owner-occupied dwelling prices rose 67.2% (54% in real terms) (from 2000 to 2012).
How did that happen? Well ahem..
By end-2014, the size of Switzerland’s mortgage market was around 140% of GDP, far higher than the about 75% of GDP in 2000
I would imagine that mortgage finance in Switzerland is rather cheap right now wouldn’t you. The BBC television program A Question of Sport has a section entitled What Happens Next? I anticipate some work for the UBS Swiss Bubble Index don’t you? Or as it puts it.
Because of the negative nominal interest rates, residential rental property purchases will become more attractive.
Back in 2011 such a subject appeared to be on the mind of the SNB as it published a working paper by Iva Cecchin on the subject of how mortgage interest-rates follow official ones.
It emerges that the pass-through is very fast and complete for fixed-rate-mortgage rates, whereas it is sluggish and incomplete for interest rates of floating-rate mortgages.
Not what we might have expected perhaps and the SNB will be grinding its teeth at this bit.
Furthermore, banks clearly react more quickly on impact to falling benchmark rates than in the opposite case. This result is robust across products.
So watch this space. We know that at the end of 2014 annual house price inflation was just over 2%, how will it end 2015?
We see that having an appreciating currency over time has led to extraordinary developments in Swiss financial markets. They now face not only negative interest-rates but also bond yields as of course we also see negative inflation or price falls. However the real economy has proved very resistant to all this so far. One measure of economic trouble in these times is the unemployment rate but look at today’s update.
The unemployment rate fell from 3.5% in February 2015 to 3.4% in March.
So we have not only a low absolute level of unemployment but a monthly decline. What about expected economic growth?
For the year as a whole, the SNB now only expects real GDP to increase by just under 1%.
So not much but in the circumstances not the catastrophe some economics textbooks would imply. Surely trade must be a disaster? Well so far,so good.
In the fourth quarter of 2014, the current account surplus amounted to CHF 17 billion, CHF 3 billion more than in the year-back quarter.
If currency appreciation is like this why are so many trying to depreciate? It would make a good PhD thesis don’t you think? As to economic theory the Swiss may well prefer to listen to Paloma Faith than read it.
I tell you what (I tell you what)
What I have found (What I have found)
That I’m no fool (That I’m no fool)
I’m just upside down (Just upside down)
Ain’t got no pain (Ain’t got no pain)
I aint got no rules (Aint got no rules)
I think I like (I think I like)
Living upside down (Living upside down)