On Wednesday, the SNB announced it was expanding its negative rates policy on sight deposits to include a larger number of institutions, to try to further discourage money being parked in Switzerland and offset the safe-haven bid that has driven CHF ever higher.
It means there are fewer exemptions to the central bank's negative rates regime, bringing a number of public-sector institutions within its scope, leaving institutions within the social security system as the only organizations whose deposits at the SNB are fully exempt.
According to UBS, the biggest source of increase is from Publica, the pension fund of the Swiss Confederation, which has assets under management of CHF38 billion. This means around CHF2.6 billion of its assets are now subject to the negative charge – an expansion of around 1.7% of the original balance.
The move saw CHF take its biggest tumble in two months. Yet even after the fall, some were arguing the Swiss franc has further to go, with John Hardy, head of FX strategy at Saxo Bank, describing CHF as “extremely overvalued”.
Pay for the privilege
The announcement was the latest move in the SNB's concerted strategy to weaken its currency through aggressive rate cuts. It has targeted three-month CHF Libor at -0.75% in a -0.25 to -1.25% corridor, with the rate hovering around the -0.80% level recently.
This means investors are being asked to pay the SNB for the privilege of lending it money.
“It is the first time in history that it will effectively cost investors to lend money to a government for such a prolonged period of time,” says Nicholas Ebisch, analyst at Caxton FX.
This they appear willing to do, with Switzerland's safe-haven status meaning traders are effectively paying a fee for the country to safeguard their assets in today's uncertain world.
“The cost of these bonds shows the willingness that investors have to invest in Switzerland as a safe haven, with the expectation that the currency will appreciate over time against its counterparts to provide a real return,” says Ebisch.
Ebisch believes a negative yield on an investment might be the new price of safety in the European post-financial crisis world, adding: “We have entered a world of negative bond yields in Switzerland and elsewhere, as the expectation of inflation continues to dwindle.”
|Any future changes in monetary policy will have |
a drastic effect on their currency
Nicholas Ebisch, Caxton FX
Another country in a similar situation is Germany, where Bunds also offer negative yield, notes Josh O'Byrne, FX strategist at Citi: “It has more to do with liquidity than FX. Three-month Libor is currently -83 basis points. So CHF might not make money but at least it won't lose 5% to 10% as seemed likely with the euro in February and March.”
However, with negative rates having so far proved insufficient to discourage international investors from ploughing money into Switzerland, the SNB might have backed itself into a corner, with it having little room to normalize its rates policy.
Ebisch says: “Any future changes in monetary policy will have a drastic effect on their currency,” meaning Switzerland will have to think carefully about raising rates, which would, in conjunction with its safe-haven status, attract even more funds and see the franc strengthen.
Perhaps this is not a problem: certainly there is little reason why the SNB cannot hold rates at their current levels for the foreseeable future.
However, Chris Turner, head of FX strategy at ING, has questioned the efficacy of the strategy, opining that “CHF interest rates are not negative enough to encourage CHF outflows”.
At -100, current EUR/CHF 12-month forward points are some way from the -160 levels seen in January, let alone the -225 levels seen in 2011, notes Turner.
“It would probably take an implied CHF yield of something like -10% to 12% to discourage those continuing to hold CHF as a safe-haven currency,” he says.
“Negative charges have had absolutely no impact so far,” adds Turner (see chart below), noting that neither CHF holdings of Swiss banks or CHF sight deposits of foreign banks have shrunk.
“The main problem is that the move lacked credibility.”
He argues the banks subject to minimum reserve requirements could exempt 20 times their minimum reserves – nearly CHF300 billion of their CHF377 billion sight deposits. Bank deposits were unaffected by Wednesday's move.
Turner says: “If the SNB wanted to get more serious about these charges, it would cut the 20 times minimum reserve exemption and aggressively raise the charge. The problem is that the Swiss buy side is complaining – it has lower exemptions.”
Switzerland's main problem is that the nervousness in the markets has been offsetting its efforts, with the currents of safe-haven flows proving too strong. The market is waiting for clarity about the fate of Greece and some evidence that the eurozone economy is reflating, before assets are redeployed into higher yielding – or indeed, anything yielding – currencies.
Geoffrey Yu, senior FX strategist at UBS, says: “So far, this has not happened, and unless drastic changes in the external environment take place, the accumulation of liquidity pools in Switzerland will continue to bolster franc strength.”
There has been a psychological barrier at the parity level between the franc and the euro, leading to speculation that the SNB might try something more radical to drive the currency lower, including, perhaps, a new euro peg – but few see this as a realistic option.
Caxton FX's Ebisch says: “The SNB will most likely exhaust other options to control currency appreciation other than a repeat of a currency peg”.
However, with the SNB's intentions still unclear, and traders still smarting from the chastening experiences of January, liquidity in the CHF/EUR trade remains below last year's levels, with many preferring to wait on the sidelines for now.
O'Byrne says: “CHF/EUR is still not fully normal or comparable to other crosses and there is probably less interest to trade it relative to the days when the floor was in place and there was a short CHF consensus.
"Volatility is very modest at the moment so you would need a very large position to make good returns. People just aren't quite ready for that yet, with still some gap risk either way.”'Too worked up'
However, with Wednesday's move down under its belt, Saxo's Hardy believes CHF will continue steadily weakening from here.
“As long as growth continues to pick up and we see more signs of credit moving through the European economy, I think CHF will decline,” he says.
“The market is getting too worked up over the Greece situation, but by July at the latest we should have some clarity on that and that should reverse some of these safe-haven flows. We will probably see the market responding to ad-hoc news items with moves of 2% to 3% at a time, but in a compressed period as we get clarity on Greece.”
In any case, it could be years before market rates re-enter positive territory.
Citi's O'Byrne says: “I expect negative rates to persist until we see marked increase in inflation, which is likely to take at least a few years.”
However, Hardy thinks the SNB will be looking elsewhere for indications it should normalize rates.
“The decision to end negative rates will be taken in the rear-view mirror, when the SNB decides that the situation in Europe has improved and the policy is no longer needed and the market is selling Swiss francs again.”