The SNB is caught between a rock and a hard place

Market analysis - 2/29/2016

With the European Central Bank (ECB) set to further cut its deposit rates, the Swiss National Bank (SNB) finds itself in a delicate situation. In December, when the ECB cut its deposit rate to -0.3%, the SNB decided not to follow suit. But when 10 March rolls around, the SNB may not again have that luxury.

As things currently stand, SNB Chairman Thomas Jordan has only three options:

1. he can let the franc rise,
2. he can massively expand the SNB’s forex reserves, or
3. he can bring deposit rates deeper into negative territory.

The franc is already significantly overvalued – around 20% of its value calculated on the basis of purchasing power parity (PPP, see left-hand chart below). If the franc were to appreciate any further, Swiss exporters would feel the brunt of it.

Forex reserves are already sky high. They have reached 575 billion Swiss francs. The SNB’s balance sheet is now equivalent to 92% of the country’s GDP. It is difficult to find other countries with such riches in their central bank vaults (see right-hand chart below). Unless the SNB again cuts its interest rates, it will have to buy up forex in order to keep the franc from rising further. It has already purchased over 15 billion francs’ worth of currencies in 2016. But with the ECB’s monetary creation moving ahead at a pace of 60 billion euros per month, the SNB will not be able to keep pace for long.



The logical choice is to continue down the path of negative interest rates. This solution does have some disadvantages, such as allowing bubbles to form, but economic growth and inflation figures in recent quarters represent no obstacle to a further cut in key rates. And this is in line with optimal monetary policy approaches, like John Taylor’s (see chart below).



This approach in particular would stipulate a deposit rate of -1.75%. Even a smaller cut – by 25 or 50 basis points to -1.00% or -1.25% – would not be excessive. In Shanghai, SNB Chairman Jordan confirmed that a further cut was possible, as was a reduction in the exemption threshold, which is currently 20 times commercial banks’ required reserves.

Another way of understanding the corner into which the SNB is backed is to compare real interest rates in Switzerland with those in other countries. With a deposit rate of -0.75% and annual inflation of -1.3%, Switzerland’s real interest rate is +0.55%, the highest among developed countries (see left-hand chart). The difference is especially striking when it comes to its main economic partner, the eurozone (see right-hand chart). As investors, we should take comfort in this: as long as real interest rates are this high in Switzerland, it makes sense to hold francs.



Unless Switzerland decides to create a sovereign wealth fund (see the box below: "WHAT COULD A SOVEREIGN WEALTH FUND DO FOR SWITZERLAND?"), it will have no other choice but to work with the three monetary levers at hand. Because the SNB governors are not happy with any of these solutions, they may end up finding a compromise solution among the three. 


They will probably let the franc rise a little against the euro, only stepping in forcefully to prevent the exchange rate from dropping below parity. To make things easier, they should also further lower deposit rates (and exempted reserves). The deposit rate is currently -0.75% and should drop to between -1.00% and -1.25% in the next few quarters. Bond markets are already pricing in a further 25 basis-point cut (see chart above). Switzerland would not be the first country to take its deposit rates so low. The rate in Sweden was cut to -1.10% last July and then dropped to -1.25% on 17 February 2016.



In 2008, when the financial crisis and then the European debt crisis broke out, the Swiss National Bank (SNB) held 47 billion Swiss francs’ worth of forex reserves. Today this figure is 12 times higher: 575.4 billion francs (see left-hand chart). These reserves are mainly German bonds (see right-hand chart), which return between -0.6% and +0.1% depending on their maturity (from 1 to 10 years). The debate is old but has renewed relevance. Why not channel this excess liquidity into higher paying investments? Why not create a sovereign wealth fund, like in Norway and Singapore? Why not safeguard Switzerland's long-term prosperity?



The first step is to determine whether Switzerland really is rich or if these savings are artificial. There are three ways for a country to boost its savings:


  1. by selling a commodity, like Norway and Middle Eastern countries do,
  2. by selling goods or services, like Switzerland and Singapore do, or
  3. by creating money with a printing press, like the SNB is doing.

The first two methods represent true value creation and real wealth, while the third method is smoke and mirrors. The situation in Switzerland is somewhere between the second and third methods. People who say that Switzerland does not have oil are right, but the country has been doing a very good job of sell ing goods and services for decades. Swiss companies operate in very high value-added segments and are increasingly geared towards high growth countries, including emerging markets. And the results are visible. The country’s current account balance is strongly positive. It is equal to 10% of GDP (see chart below). This is the highest level among the major developed countries. A positive current account balance means the rest of the world is in debt to Switzerland. Switzerland's wealth is thus not completely artificial, that much is clear.




These savings can be used in two ways by Swiss households, companies, pension funds, cantons, etc. The money can either be reinvested abroad or kept for domestic projects. In the first case, financial flows offset trade flows, and in the second case the franc gets stronger.

Since the debt crisis in Europe, the Swiss have lost confidence. They no longer wish to invest as much as before in European projects, whether it is in property, corporate buyouts, stocks or bonds. Savings are kept in Switzerland instead of being exchanged for euros, for example. Because Switzerland is no longer a net foreign investor, the franc is rising. The historical equilibrium that held for the past 25 years has now been upset. And we find ourselves in the same type of situation as in the 1970s, when the value of the dollar went from four to two francs.




But this time, the euro went from 1.60 to 1.10 francs (see chart). And this situation could become the status quo. Switzerland’s conomic and political stability differ starkly from the structural problems seen in the eurozone.

The upward pressure on the franc is so strong that it is weighing on economic growth and undermining price stability. In 2008, the SNB chose to intervene to slow the franc’s rise by setting up an exchange-rate ceiling. This monetary policy decision led the SNB to buy up hundreds of billions of euros to invest in Europe, mainly in German bonds, as mentioned above.

Unfortunately, in 2015 the ECB’s decision to create euros made Switzerland’s monetary policy more difficult to sustain. The SNB then dropped the euro peg in order to prevent its forex reserves from rising too far, too fast. To  counterbalance its aggressive action on the currency market, it cut its key interest rates. It is attempting to dissuade the Swiss (households, businesses, pension funds, etc.) from hoarding their francs and encourage them to invest in Europe. This is having an effect, but the low interest-rate policy is feeding the risk of a property bubble and of instability in the banking system.

The Swiss are not inclined to invest in Europe, and the SNB cannot simply work a miracle. So how can the franc’s rise be held in check? One possibility would be to create a sovereign wealth fund. Whether the money in the fund comes from the SNB’s surplus forex reserves or from another source, the idea is the same: invest our wealth abroad to reduce pressure on the franc while saving for the future.

Without going into administrative and political details, a sovereign wealth fund must respect three main criteria. It must:


  • serve the general interests of Switzerland: with investments in strategic or innovative sectors, or those with a link to sustainable development, for example;
  • allow the country to maintain its monetary policy independence: the SNB must be the one to decide whether or not to channel of its reserves into the fund; and
  • be reversible: during inflationary periods, the SNB must be able to reduce liquidity.

A sovereign wealth fund would benefit the SNB in terms of its monetary policy, including renewed balance-sheet stability and an ability to raise interest rates (see left-hand chart). It would also prevent financial and credit bubbles from forming, a concern regularly voiced by SNB officials like Mr Jordan, Mr Danthine and Mr Zurbrügg (see right-hand chart).




Another key point is that a sovereign wealth fund must not create additional money. It can only change how money is used. Switzerland has the wealth, it just needs to invest it differently. A sovereign wealth fund could invest in the euro when it is low and sell it when it gains strength. What more could we want?







  • The GDP growth rates shown above are actual for 2014 and 2015 and projections for 2016.
  • Each country’s weighting is based on its GDP in US dollars as calculated by the World Bank.
  • Contributions to global expansion are calculated by multiplying the GDP growth of each country by its weight. The sum of the contributions works out to 3.4% for 2016, a good estimate of this year’s global GDP growth.




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