The Swiss mixture of negative interest-rates, currency intervention and equity investing

Today brings an opportunity to look at a consequence of several economic themes. The opening one is related to the way that in both economic and currency terms the Euro is something of a super massive black hole. This accompanies and has exacerbated issues caused by what was called the carry trade in the years that preceded the credit crunch. Back then borrowers both individual and corporate decided to take advantage of cheaper interest-rates abroad and in particular used the Swiss Franc and the Japanese Yen. This meant that both currencies soared and in the early days on here I christened them the currency twins for that reason. Both currencies were bounced around by this as at first as the trade was put on they were depressed but later as the credit crunch hit and nerves replaced greed both currencies soared. This showed how even national economies were to this extent the playthings of international currency flows and meant that Switzerland had elements of the Japanese experience.

Thus it should be no great surprise to see a country with elements of the Euro and the Yen experience finding itself in the cold icy world of negative interest-rates, From the Swiss National Bank earlier.

The Swiss National Bank (SNB) is maintaining its expansionary monetary policy, with the
aim of stabilising price developments and supporting economic activity. Interest on sight deposits at the SNB is to remain at –0.75% and the target range for the three-month Libor is unchanged at between –1.25% and –0.25%.

This goes through to some extent on the nod these days but if we look at the economic situation we see something that is increasingly familiar.

In Switzerland, GDP grew in the fourth quarter at an annualised 2.4%. This growth was again primarily driven by manufacturing, but most other industries also made a positive contribution. In the wake of this development, capacity utilisation in the economy as a whole
improved further. The unemployment rate declined again slightly through to February. The SNB continues to expect GDP growth of around 2% for 2018 and a further gradual decrease in unemployment.

We set yet again that expansionary monetary policy coincides with economic expansion and there is a contradiction. We are told by the SNB that manufacturing is leading the charge whilst it also tells us that the Swiss Franc is at too high an exchange-rate.

The Swiss franc remains highly valued. The situation in the foreign exchange market is still fragile and monetary conditions may change rapidly. The negative interest rate and the SNB’s willingness to intervene in the foreign exchange market as necessary therefore remain essential. This keeps the attractiveness of Swiss franc investments low and eases pressure on the currency.

In other words perhaps the currency is not as big a deal for an area you might think would be price competitive and no doubt the situation below is a factor in this.

The international economic environment is currently favourable. In the fourth quarter of 2017,
the global economy continued to exhibit solid, broad-based growth. International trade
remained dynamic. Employment registered a further increase in the advanced economies,
which is also bolstering domestic demand.
The SNB expects global economic growth to remain above potential in the coming quarters.

So is the Swiss Franc too high as the SNB keeps telling us? If you think of foreign exchange markets as being “fragile” in one of the better periods for the world economy when can you ever leave the party?As you can see below the rhetoric is still the same.

The SNB will remain active in the foreign
exchange market as necessary, while taking the overall currency situation into consideration.

The Swiss Franc

Actually the indices of the SNB also pose a question about its policy as it has various real exchange rate indices and they are between 104 and 110 now if we set 2000 as 100. This is different to the nominal measure which is at 153. So the situation is complex as the carry trade pushed it down and then sucked it back up. Of course the SNB would say its policies have helped ameliorate the situation.

Hedge Fund alert

The enthusiasm of the SNB for currency intervention especially in the period running up to the 20th of January 2015 has led to it becoming one of the world’s largest investors. This is because in an unusual situation – from the Uk’s perspective anyway – it has intervened to keep its currency down rather than up so it has bought foreign currencies. this meant that it needed some sort of investment strategy.

The majority of the SNB’s foreign currency investments are in government bonds, bonds issued by foreign local authorities (e.g. provinces and municipalities) and supranational organisations, as well as corporate bonds, or are placed at other central banks. The proportion of equities is one-fifth. Two-fifths of the foreign currency investments are denominated in euros, and more than one-third in US dollars. Other important investment currencies are the pound sterling, yen and Canadian dollar.

As there were some 790 billion Swiss Francs of reserves as of the end of last year this is a big operation. With equity markets rising it has been profitable and of course over time so has the bond investing even allowing for recent tougher times. This has led to this.

Another important project was the renewal of the profit distribution agreement  between the Federal Department of Finance (FDF) and the SNB, which defines the amount of the annual profit distribution to the Confederation and
the cantons.

Yet as I pointed out on the 3rd of October last year there are also private shareholders.

Cantons own 45% of stock, cantonal banks 15% and private investors (individuals or institutions) the remaining 40%.

This has led to quite a lot of speculation that one day the private shareholders might get a share so to speak. This is how it looked back in October.

Less than a month after its stock smashed through the 3,000-franc-a-share barrier, SNB shares hit an intraday high of 4,324 on Wednesday and were trading as high as 4,600 on Thursday. The stock has tripled in value from a year ago, repeatedly confounding market watchers by regularly hitting records.

The price is now as of the last trade 5640 Swiss Francs so the rumours continue. We get many stories about central banks being privately owned which are usually not true whereas here there is some truth  to it.


There is a lot to consider about the present Swiss situation where we again see negative interest-rates and a different type of balance sheet expansion combined with recorded economic growth that is solid. We also see some familiar risks.

Imbalances on the mortgage and real estate markets persist. While growth in mortgage lending remained relatively low in 2017, prices for single-family houses and owner-occupied apartments began to rise more rapidly again. Residential investment property prices also rose,
albeit at a somewhat slower pace. Owing to the strong growth in recent years, this segment in particular is subject to the risk of a price correction over the medium term.

Things take a further step forwards when we note their line of thinking.

The SNB will
continue to monitor developments on the mortgage and real estate markets closely, and will
regularly reassess the need for an adjustment of the countercyclical capital buffer.

It seems as though rather than stepping back they might intervene even more reminding me of the words of Joe Walsh.

I go to parties sometimes until 4
It’s hard to leave when you can’t find the door

Me on Core Finance TV

The currency problems of the Czech Republic mount

Today I wish to take a journey to central Europe to take a look at a place which was described by British Prime Minister Neville Chamberlain in September 1938 like this.

“How horrible, fantastic, incredible it is that we should be digging trenches and trying on gas-masks here because of a quarrel in a far-away country between people of whom we know nothing.”

Of course there are some geo-political issues of that time which are recurring but as we note that the country of back then was spilt into two as we now have Slovakia and the Czech Republic there is something else to interest us. This is the exchange-rate policy of the Czech National Bank (CNB).

The CNB therefore decided in November 2013, in accordance with its statutory mandate to maintain price stability and in line with its previous communications, to start using the exchange rate of the koruna as an additional monetary policy instrument.

A slightly curious description as in preceding paragraphs they told us that what we would now call Forward Guidance on the subject had been working.

caused the Czech koruna to weaken in late 2012/early 2013

We are of course familiar with central bankers struggling with reality and Forward Guidance being a particular problem on this front with up regularly being the new down. However in spite of the claimed improvement we find ourselves noting that yet again what is described these days as “Moar” was required.

The CNB undertook to intervene in the foreign exchange market to weaken the koruna so as to maintain the exchange rate close to CZK 27 to the euro. This exchange rate commitment is asymmetric, i.e. the CNB will stop the koruna appreciating below CZK 27 to the euro but will leave any further depreciation above CZK 27 entirely in the hands of supply and demand on the foreign exchange market.

What is the significance of this?

The first is simply geography and I mean by this proximity to the Euro which has caused problems for a raft of countries around it most notably Denmark and Switzerland with their negative interest-rates. Also the Swiss National Bank has become an enormous hedge fund via its currency interventions and recycling policy. Right now with equity markets on highs that looks a cunning plan but of course trying to realise it on any scale could switch that to the sort of cunning plan espoused by Baldrick in the television series Blackadder.

Next comes the issue that the more you fix the exchange-rate the less you can do about internal monetary policy. As the Swiss have found above the money supply and other matters cannot now be controlled. There is a Swiss like element to the policy.

The CNB can use infinite amounts of koruna to purchase foreign currency, as it itself issues the Czech currency in both paper and electronic form. The CNB is resolved to intervene in such volumes and for such duration as needed to maintain the chosen exchange rate level.

Be careful what you promise! Anyway the Koruna went above the 27 level until late summer 2015 since when if you are willing to ignore minor moves a fixed exchange-rate at 27. The price of this is that it needed to intervene starting at just over 1 billion Euros worth in July 2015 and peaking at just under 4 billion last October. The small-scale is probably simply the fact that for many of the main currency players and investors it is too small a market to bother with and that is for those who know it exists! Sometimes small is indeed beautiful.

What happens next?

Well on the 22nd of December this was decided.

The Bank Board therefore states again that the CNB will not discontinue the use of the exchange rate as a monetary policy instrument before 2017 Q2. The Bank Board still considers it likely that the commitment will be discontinued in mid-2017.

I guess worries immediately arise about any Forward Guidance from a central bank as we note that exit strategies if we are being polite have proved to be somewhat problematic. This morning’s update from the Czech Statistical Office has brought this into focus.

Consumer prices in December increased compared with November by 0.3%…….. The year-on-year growth of consumer prices amounted to 2.0%, i.e. 0.5 percentage points up on November. It is the highest year-on-year price growth since December 2012.

This is a bit like the point where a train or aircraft announces that you have arrived at your destination! What caused this?

The month-on-month rise in consumer prices in ‘food and non-alcoholic beverages’ came primarily from the increase in prices of vegetables by 10.6%, of which prices of vegetables cultivated for their fruit rose by 40.8%.

Are “vegetables cultivated for their fruit” tomatoes? Anyway the Czechs are seeing an outbreak of food inflation which of course hits the poorest the most.

Prices of rolls and baguettes were higher by 10.4% (1.5% in November), eggs by 13.7% (10.3% in November), fresh butter by 20.7% (16.6% in November). Prices of vegetables cultivated for their fruit were higher by 41.5% (a drop by 10.1% in November).

It looks like there are effects here which may unwind a bit but as we go into 2017 we can expect more of this if we look at the price of crude oil.

In ‘transport’, prices of automotive fuel turned from a drop in November by 0.3% to a growth by 4.3%.

Actually if we were to use the Euro area standard which has some logic if you are shadowing it as a currency then we are above the inflation target already albeit marginally.

the HICP in the Czech Republic in December went up by 0.3%, month-on-month, and by 2.1%, year-on-year.

Oh and there is a be afraid, be very afraid moment in the further detail.

So far, imputed rentals have been excluded from the HICP

If this from fastFT is any guide then the word control needs to go into my financial lexicon for these times.

Policymakers have maintained a hard upper limit on the koruna at CZK27 against the euro since 2013 in a bid to control inflation

What about unemployment?

Whilst the CNB has trouble ahead there is one area where things look pretty good and I mentioned it in passing yesterday as we looked at Germany.

the lowest unemployment rates in November 2016 were recorded in the Czech Republic (3.7%) and Germany (4.1%).

If we look more generally economic growth had disappointed a bit according to the CNB.

Industrial production growth slowed considerably, mainly reflecting an unexpected downturn in exports in October. The long-running decline in construction output, caused mainly by a drop in public investment, slowed only marginally in October. Retail sales growth remains at solid levels.

Since then we have discovered that industrial production rose by 1.3% in November on the month before making the numbers in that area look better.

More German than the Germans

If I give you a couple of snapshots you will understand what I mean.

The general government balance expressed as a percentage of GDP reached a high surplus of 2.16 percent in the third quarter of 2016…….General government consolidated gross debt decreased annually by 1.92 p.p. to 38.73 percent of GDP.

No doubt there is a (long) word in German for this but that is way beyond my language skills. Also whilst we are in a Germanic style surplus zone there is this.

In January−November 2016, trade surplus in national concept reached CZK 189.9 bn which represented a y−o−y increase of CZK 57.8 bn.


So far I have avoided the phrase competitive devaluation but this is what we have seen from the Czech Republic. To put it another way it can be labelled as “exporting deflation” as it has kept its exchange rate lower than otherwise to gain a competitive gain which means that someone else has lost via a competitive disadvantage. Not too friendly and this has been added to via the fact it has shadowed the Euro which itself has fallen. If we were looking for a concrete example of this then perhaps Reuters have shown us one earlier today.

Skoda Auto, the Czech unit of carmaker Volkswagen (DE:VOWG_p), raised global deliveries by 6.8 percent to a record 1.13 million cars in 2016, lifted by rising sales in Europe and China, the company said on Tuesday.

This leaves us with two issues. The first is that the economies trying to lower their currency are a large group if we start with the main group of the Euro area, China and Japan with the UK of course also recently depreciating. Secondly looking forwards the CNB faces the issue of how it exits if inflation picks up quickly or whether it follows the central banker philosophy of shouting both “temporary” and “counterfactual” whilst looking the other way.

How many central banks will turn into hedge funds?

One of the under appreciated consequences of all the monetary easing and intervention that has gone on in the world since the credit crunch is the impact on central banks themselves. What I mean is that they find themselves holding ever larger sums of assets which in many cases they are compounding by often holding ever riskier ones. They are taking advantage of the fact that they are backed by national treasuries – although being backed by 19 national treasuries as the European Central Bank or ECB  has a different perspective in my opinion  – allowing the view that this is somehow risk-free to proliferate. Well it may not be risk-free for the taxpayers who find themselves backing all this!

The Bank of England

So far it has mostly confined itself to what we might call bog standard QE where it purchases UK Gilts. However it has been lengthening the maturity of its £375 billion of holdings in an Operation Twist style and now for example has some £989 million of our 2068 Gilt. Too Infinity! And Beyond! Indeed…

The main risk to taxpayers is in fact even less understood operations like the house price boosting Funding for Lending Scheme. Some £69 billion of cheap loans to banks have been issue here and should house price ever fall there are risks.

Foreign Exchange Reserves

These seem to be safe but the QE era has led to changes here because you see conventional theory has central banks investing in shorter dated bonds. Some of you will be spotting the problem already! This is how the Financial Times puts it.

European and Japanese (interest) rate cuts are putting pressure on many central banks’ returns — a source of income used to cover running costs and to provide finance ministries with profits on which they have come to rely.

In other words investing at negative yields carries a guaranteed loss if you hold to maturity which is awkward to say the least when you come to explain your stewardship to auditors and indeed taxpayers. The ECB in particular is hoist by its own petard here as I recall it arguing that value on maturity was the way of valuing Greek bonds back in the day and of course that is still convenient there. But not elsewhere. We have just excluded the Euro and the Yen which of course are major markets (even now some 20% and 4% of reserve assets respectively) and logical ones to put some of your reserves. So what are they doing? From the FT.

central bank reserve managers are making or “seriously considering” buying bundles of loans repackaged as asset-backed securities or switching out of currencies affected by negative rates.

There are issues here as we move from theoretically at least safe government bonds to what are less safe assets. There are in fact two issues which the FT does not point out so let me point them out.

The good news for central banks is that a consequence of their own actions is that they have made a profit. Of course they will not put it like that! No doubt the press communiques will concentrate on skilled management and their own abilities. But the QE era has driven the prices of the bonds they hold as foreign exchange reserves higher and hence bingo. Even the own-goal by former UK Chancellor Gordon Brown when he sold gold at what is now cruelly called Brown’s Bottom will look a little better as the replacement strategy of buying bonds does well.

The catch is for future investment as what do you do now with bond prices so high? Indeed these “independent” central bankers will be under pressure from politicians who have no doubt got used to spending the profits created for national treasuries to carry on regardless as the film put it. But where do they go now to do this? The FT gives us a nod and a wink.

But central banks have shed some of their conservatism in recent years, with monetary policies such as quantitative easing forcing them to sell bonds and buy riskier instruments such as equities.

Revealing language there via “forcing them”. Really? Many central banks are not allowed to buy equities for this purpose and so they will be buying longer-dated bonds and dipping into riskier ones. I will discuss the equity buyers in a moment but here is an idea of scale for you.

Total managed reserves were $10.9tn at the end of last year, according to the International Monetary Fund.

Even in these times of ever larger numbers that is quite a lot. By the way how do the numbers keep getting larger when we are supposed to be in deflation? Anyway the UK government has net US $ 38.4 billion which the Bank of England manages. Tucked away here is the issue that gross reserves are around US $97 billion larger as we mull we have liabilities too and the phrase what could go wrong? The bit we do know is that if it should it will not be anybody’s fault.

Riskier bonds

Moving onto a slightly different field which is QE then the ECB gave us an example of this in yesterday’s update.

Asset-backed securities cumulatively purchased and settled as at 15/04/2016 €19,220 mln……..Covered bonds cumulatively purchased and settled as at 15/04/2016 €169,255 mln.

The ABS securities are the riskiest and as an aside you may wonder Mario Draghi made such a big deal of them as in the scheme of things purchases have been relatively small. The US Federal Reserve has been a big buyer in this area and as it still hold some US $1.76 trillion does not seem to have been keen on realising the value stored there.

Equities and property

Here we find what I labelled the “currency twins” back in the day as there were many similarities between the Swiss Franc and the Japanese Yen. The carry trade pushed their currencies lower originally but reversing it post credit crunch saw them shoot higher which the respective central banks resisted. Here are the consequences.

Swiss National Bank

This has the equivalent of some US $600 billion to invest as a result of its past interventions and promises to take on all-comers. Of that some 18% was invested in equities at the end of 2015 and that is why I refer from time to time to it being affected by movements in the share price of Apple for example.

The equity portfolios in the foreign currency investments were comprised of shares from mid-cap and large-cap companies (excluding banks) in advanced economies and, to a lesser extent, shares of small-cap companies. The SNB does not engage in equity selection; it only invests passively.

I wonder what Swiss watchmakers think of their central bank using their money to invest in the creator and manufacturer of the Apple watch? But as we observe this I note that of course we do have what might be considered purist hedge fund behaviour here which is punting, excuse me invested in Apple shares. The equity component had also risen from 15% to 18%.

Bank of Japan

The Bank of Japan also has large foreign exchange reserves amounting to some US $1.26 trillion. All that intervention had to go somewhere or to put it another way we see why the Bank of Japan was reluctant to intervene again as the Yen surged a week or so ago.  The Ministry of Finance is not keen on breaking this down but we do know that in its QQE (Quantiative and Qualitative Easing) policy the Bank of Japan is a keen equity and indeed property investor. From its latest Minutes.

Second, it would purchase ETFs and J-REITs so that their amounts outstanding would increase at annual paces of about 3 trillion yen and about 90 billion yen, respectively.

The Exchnage Traded Funds or ETFs are equity purchases and the J-REITs are property ones. So far just under 7.6 trillion Yen and 300 billion Yen have been purchased respectively. Indeed there are issues building here as regards market stability and structure. From Bloomberg.

the BOJ has accumulated an ETF stash that accounted for 52 percent of the entire market at the end of September, figures from Tokyo’s stock exchange show.


There is much to consider here as we see more and more central banks make the journey to what a Martian observer might have trouble distinguishing from a hedge fund. The elephant in the room is making investments which can make losses. Also here is a conceptual question for you. Is something a profit if it results from your subsequent purchases? The Bank of Japan which is both a template and the extreme case should be mulling this today in response to this.

JAPAN’S 30-YEAR YIELD FALLS TO RECORD 0.335% (h/t @moved_average )

In this situation it may already be beyond the point of no return which poses its own questions as it chomps on Japanese financial assets “like a powered up Pac-Man” as The Kaiser Chiefs put it.

Most other central banks have only taken relative baby steps on this road but we see that in yet another “surprise” even their foreign exchange reserve management is being affected. As I note that the ECB is the central bank mostly likely to dip into equities next let me leave you with a question. How is it that people who are badged as so intelligent and skilled seem to be so regularly surprised by the consequences of their own actions?!

For a minute there, I lost myself, I lost myself
Phew, for a minute there, I lost myself, I lost myself

For a minute there, I lost myself, I lost myself
Phew, for a minute there, I lost myself, I lost myself (Radiohead Karma Police)