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Bond Outlook by bridport & cie, October 26 2011

There may be lessons from the Swiss national Banks’ negative repo rate and the failure of Dexia. Both reflect aspects of how the euro crisis has become a banking crisis.

Since we are still awaiting the results of the euro summit, and, having already made our own forecast of the outcome (see our last Weekly), we turn today to the strange case of the actions of a central bank with too much liquidity, and interest rates already at zero, viz, the Swiss National Bank. Switzerland’s problems are of course extremely unusual: the loss of confidence in both EUR and USD, and resulting flight into the CHF, pushed its exchange rate well above what is justified in terms of international trade competitiveness. The SNB announced a ceiling to the EUR/CHF exchange rate, and achieved it by buying EUR-denominated bonds.


Despite these actions, the Bank still has a massive excess of liquidity, which it would like to filter down into the economy. To achieve this, the SNB wishes to encourage the banks to borrow from it, and willingly accepts collateral of bonds in various currencies, to support this lending at the repo rate. Under normal circumstances, this repo rate is positive. However today, that is not the case. Indeed, whilst the rate is actually negative, it is less negative than the yield on Swiss T-Bills.

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