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Currency War between ECB and Swiss Nat’l Bank continues


Jul 21, 2016

    With no natural mineral resources, and a small population at just over 7.8-million, Switzerland depends on foreign trade for roughly half of its national income. Swiss manufacturers import bulky raw materials, processes them, and export most of their high-quality, finished goods. Thanks to the efforts of its highly skilled workforce; – the value of Switzerland’s exports has consistently exceeded the cost of its imports for more than a decade. In fact, in Feb ’16, Switzerland posted a record trade surplus of +Sfr-4-billion, with exports up +8% compared with a year earlier. That’s quite a remarkable achievement, considering that 60% of its exports are sold to the European Union <EU>, and the Swiss franc has become +10% more expensive versus the Euro, and +20% versus the British pound, compared with 1-½-year ago.

    Switzerland never joined the EU; – it voted against doing so in the early 1990’s, and in June ’16, its parliament formally pulled its application for EU membership that had gathered dust for over 20 years. But it has maintained a friends-with-benefits sort of relationship with the EU and over the course of decades, Switzerland and the EU have carved out bilateral agreements related to trade, mobility of citizens, and transportation. It certainly helps that about two-thirds of the Swiss population speaks German, 20% speaks French and about 7% speaks Italian. The strength of its value-added and export orient economy, has generated one of the highest Gross Domestic Product per capita incomes in the world, at US$-75,550 in 2015; – that’s the equivalent to 598% of the world’s average.

    Most Swiss firms (over 99%) are small and medium-sized enterprises (SME’s). These are defined as companies with fewer than 250 employees. They are extremely competitive in world markets, and in some industries, more than 90% of their finished goods and services are exported. The best-known export items are watches, chocolate, cheese, clocks, and jewelry, but in fact, key areas such as micro-technology, high-tech, bio-technology and pharmaceuticals, precision instruments, and machines, appliances, electronics, mechanical and electrical engineering, and chemicals together account for over half Swiss export revenues. Banking and insurance know-how account for 15%. Swiss companies need foreign markets in order to make investment in research and development worthwhile.

     According to Morgan Stanley, roughly 85% of the big Swiss multi-nationals’ sales come from outside Switzerland. Corporate giants like food maker Nestle and drug maker Novartis make almost all their money in foreign markets. As such, the Swiss National Bank <SNB> has mostly focused its monetary policy around the Swiss franc’s exchange rate versus the Euro, in order to help prevent Swiss goods from being priced out of the EU’s markets and protecting the profit margins of its exporters. Since the 2008 financial crisis, the SNB has been fighting a tough battle to keep the franc from overheating, whenever investors flocked to the safe haven currency. The franc is considered to be a top flight currency, because the federal government is fiscally conservative, running balanced budgets, while the country routinely runs trade surpluses with the rest of the world.

    Prior to the onset of the European and US-banking crisis in July 2007, 1-Euro could purchase 1.65-Swiss francs, but over the course of the next 4-years, the Euro would plunge into a downward spiral, and crashed towards parity with the Swiss franc, hitting a life-of currency low at Sfr-1.01 in July ‘11. The Euro’s sharp decline in purchasing power was a major threat to the profitability of Swiss exporters, and would threaten to push the Swiss economy into a deflation trap.

    As such, in Sept ’11, the SNB announced that it would sell an unlimited amount of Swiss francs, in order to enforce a floor under the slumping Euro’s exchange rate at a “minimum” exchange rate of SFr-1.20 /Euro. “The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development,” the SNB warned. The SNB’s surprise attack worked. The Euro quickly rebounded to above the SFr-1.20 level. The SNB guided interest rates lower to enforce the Euro’s floor, and led the 2-year Swiss bond yield to zero percent.  

      The SNB sold Sfr-300-billion in the foreign currency market, in exchange for Euros, and was able to buoy the Euro at or slightly above Sfr-1.20 for the next 40-months, until January 15th, 2015. In essence, the SNB was engaging in a quasi “quantitative easing” (QE) scheme, printing currency with the aim of driving down its exchange rate, rather than purchasing bonds to rig long-term interest rates. Given the weak economic outlook, most governments would like to see their currencies fall to give their exporters a chance of seizing a bigger share of global trade. The SNB felt it had no choice. Swiss exporters were suffering from the strength of the franc. Clariant, a chemicals group, and watchmakers, Swatch <UHR.VX>, and Richemont <CRF.VX>, blamed weaker profits on the currency.

    “The minimum exchange rate will be kept in place for as long as necessary for monetary policy,” said SNB chief Thomas Jordan in a Sept 2nd, 2013, interview with the Bieler Tagblatt. However, a little over a year later, in Nov 21st 2014, the ECB was throwing the door wide open for more dramatic action to rescue the Euro zone economy from “excessively low” inflation, “by whatever means necessary.” ECB chief Mario Draghi warned it would expand its easing campaign to pump more Euros into the money markets. “We will continue to meet our responsibility – we will do what we must to raise inflation and inflation expectations as fast as possible, as our price stability mandate requires of us. We will step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our bond purchases.”

    On Dec 5th, 2014; word was leaked to the media, that the ECB was preparing to buy around €1-trillion worth of Euro-zone government bonds, and thus, breaking the taboo of monetizing government debt. On Dec 24th, 2014, the SNB tried to counter the ECB’s moves, by saying it would charge its banks a negative interest rate of -0.25% on commercial bank deposits, figuring a negative deposit rate would discourage investors from buying the Swiss franc.

    On January 3rd, 2015; — ECB chief Mario Draghi said the governing council was ready to authorize the supply of even more ultra-cheap Euros to financial markets, at its next meeting on January 22nd. Asked by the German business newspaper Handelsblatt, about his aim of expanding the ECB’s balance sheet by €1-trillion, Draghi said: “We are making technical preparations to alter the size, pace and composition of our measures in early 2015, should it become necessary to address risks of a too-prolonged period of low inflation. The governing council agrees unanimously on that.”

    On Jan 5th, SNB chief Thomas Jordan tried to counter the ECB gambit, saying the SNB was still obliged to intervene to ensure its target of a minimum exchange rate of Sfr-1.20 /Euro was met. Jordan said; “the target would be pursued with the utmost determination. The minimum exchange rate is still the key instrument to avoid an undesirable tightening of monetary conditions and to maintain price stability.” Jordan termed it “absolutely central.” “The SNB is prepared to buy unlimited quantities of foreign currency to enforce the minimum exchange rate. If it becomes necessary, we can take further measures, such as a further reduction of interest rates,” he warned. On Jan 13th, 2015; SNB deputy Jean-Pierre Danthine said the 1.20 ceiling would remain a “pillar” of monetary policy.

    However, the reality was, the massive scope of the ECB’s money printing spree, at €1-trillion, would have required the SNB to print Swiss francs equal to twice the size of Switzerland’s annual GDP, in order to defend the Euro at Sfr-1.20. As such, facing the probable onslaught of €1-trillion from the ECB, the SNB decided to retreat. On Jan 15th, 2015, the SNB scrapped its three-year-old defense line at 1.20 per Euro, saying it had become unsustainable. The move sent the franc soaring, prompting firms across Switzerland to warn of a plunge in profits, with the luxury, industrial and tourism sectors most exposed. With inflation already running at -0.3% year-on-year, Switzerland was also risking importing deflation. In a knee-jerk reaction, Switzerland’s benchmark SMI index fell as much as -14% during the trading day in Zurich. Weaker equities wiped off about Sfr-117 billion from the SMI share index, with Swatch, Richemont and biotech firm Actelion <ATLN.VX> among the biggest losers, down -14% to -17%.

     The Swiss franc jumped to a record against the Euro and rose to its highest in more than three years against the US$ following the announcement. The Euro initially plunged -41% to as low as Sfr-85.17 following the stunning announcement, the lowest level on record. Against the US$, the Swissie jumped +14% to as high as $1.14. The counter the surging Swiss franc, the SNB quickly dropped the 3-month Libor rate to a stunningly low of -260-bps, and lifting the Euro into the Sfr-1.02 to Sfr-1.08 from the next several weeks. On March 8th, the SNB warned it could push interest rates further into negative territory if the franc moves in the “wrong direction”, The Swiss newspaper, Schweiz am Sonntag said “a rate of minus -1.50% is being considered,” in a bid to discourage investors from piling into the safe-haven Swiss franc. Negative rates effectively mean banks are paying the SNB to hold their money.

    Since the ECB launched QE in March 2015, the size of the ECB’s bond portfolio has increased by €1.15-trillion, and it is charging Euro-zone banks -40-bps to park their excess cash at the ECB. In turn, the SNB is charging its banks -0.75%, which is meant to dissuade foreign investors buying and holding Swiss francs as a safe haven investment. The target range for the three-month Libor also remained unchanged at between -1.25% and -0.25%, but it has averaged -1% for the past 12-months. “Our monetary policy continues to be based on two key elements: the negative interest rate and our willingness to take an active role in the foreign exchange market, SNB chief Jordan explained on June 16th, 2016.

    “Both are intended to make Swiss franc investments less attractive, thereby easing pressure on the franc,” he said, pointing out that “the franc remains significantly overvalued. The SNB has achieved a degree of stability for the Euro /Franc at between Sfr-1.07 and Sfr-1.11 for the past 12-months. Following the Brexit vote, the key exchange rate had plummeted to Sfr-1.06 before the SNB intervened to bring it up to Sfr-1.087. The SNB’s foreign exchange reserves increased +Sfr-6.5-billion worth of foreign currencies in the month of June, and breached the Sfr-600 billion mark for the first time. That’s up from Sfr-500-billion, when the SNB, pulled the plug on its Euro /franc exchange rate peg in January 2015.

    However, the super strong Swiss franc is weighing on the local economy, Swiss consumer prices rose +0.1% in the month of June, but were -0.4% lower compared with a year earlier, and unchanged from the May rate. It was the 20th straight month of deflation. Inflation in Switzerland averaged +2.5% from 1956 until 2016. There are fears that a sustained pattern of deflation could choke the life out of the Swiss economy by encouraging consumers and businesses to delay spending in the hope of bargains down the line. In turn, the yield on Switzerland’s 2-year government note is last quoted at -92-bps, or slightly lower than the 3-month T-bill yield at -87-bps, or slightly inverted.

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