Here we go again… hints of a negative rate regime in Switzerland.
But this time it’s not the SNB that’s hinting it, it’s the Swiss government.
Switzerland’s government said it may consider additional measures including negative interest rates to support the country’s central bank in its fight against the appreciation of the Swiss franc.
The government is willing to “examine the feasibility of supporting measures within the context of an overall consideration,” it said yesterday in response to a parliamentary inquiry by Green Party member Louis Schelbert.
Part of the supporting measures would be the introduction of negative interest rates, it said. Still, the most effective tools to fight excessive exchange rate fluctuations remain in the areas of foreign exchange and monetary policy that are the Swiss National Bank’s responsibility, the government said.
First observation: what is the Swiss government doing mulling negative interest rates? Is that not the job of the central bank?
Well, as it happens there’s a funny story here.
As we noted back in August, when “le plan, negatifs taux d’intérêt” first reared its head, the SNB was targeting a three-month libor rate of “as close to zero as possible” by expanding banks’ sight deposits at the SNB from CHF30bn to CHF80bn. To achieve that expansion it had to intervene in the all-important repo market.
As they wrote:
Consequently, with immediate effect, the SNB will no longer renew repos and SNB Bills that fall due and will repurchase outstanding SNB Bills, until the desired level of sight deposits has been reached.
“As close to zero” for three-month Swiss libor, de facto, meant negative rates in any rates shorter than that — a regime which the SNB hoped would discourage finally Swiss-franc deposits.
The problem was that the sub-three month rates simply wouldn’t stay negative. Demand for Swiss deposits was much harder to break than they anticipated:
Part of the problem was that even though the SNB doesn’t pay interest on deposits, the zero-rate itself began to have an effect. Banks preferred to stay in Swiss francs receiving zero in overnight deposits than move out into other currency systems. Rates in Switzerland couldn’t move beyond zero, and that meant Swiss deposits were still seen as a safe store of value.
The zero interest on reserve had effectively turned into a very significant floor on short-term rates.
Of course, stashing cash at the Swiss central bank was never part of the SNB’s original plan — it wanted people to move out of the franc completely.
By September the central bank had realised that if it was to really discourage inflows into Swiss francs, it would either have to get rid of the zero floor completely or go down the nuclear FX option. As we now know, on September 6 it chose the latter, by announcing a floor of SFr1.20 on Swiss franc/euro exchange rate.
In market terms, that was the equivalent of signalling it was prepared to buy as many euros as it took to achieve the rate, largely by ‘printing money’ – the FX version of quantitative easing, if you will.
Now, even though most analysts believe the SNB didn’t have to buy too many euros to achieve its objective, the point still stood that it was prepared to do so if challenged.
But in today’s negative yielding bund environment, that stance has now become incredibly risky due to the investment challenge that unlimited euro purchases pose. Ultimately, there are only so many quality euro-denominated assets out there and there’s already a collateral crunch.
If these assets start yielding a negative rate (say, like bunds did this week) and the SNB buys them, that just means the SNB is paying someone else for the privilege of investing its capital in those securities. The SNB itself yields nothing. Worse still, its money begins to depreciate over time.
If it was the case that the SNB started putting large sums of money into German bunds at a negative rate, you could even say it was beginning to subsidise the Eurozone system. Paying up a negative rate for the privilege of investing in its debt, because it couldn’t dispose of its euros in any other way.
What’s a Swiss National Bank to do?
Well, apart from joining the eurozone, realise that negative rates are an inevitability and go back to its original plan negatifs taux d’intérêt on home ground — since you seemingly can’t get rid of either deflation or risk, just push it around.
But how does the SNB now introduce negative rates?
It would have to lift the zero floor on deposits, and in order to that it would somehow have to convince banks to pay it for the privilege of investing their cash overnight on reserve. This could be done via a tax or a charge — both of which might need government approval. Hence the government role.
Though it’s worth asking if it was the SNB’s FX intervention which intensified the euro-denominated collateral crunch and liquidity drain in the first place?
If that’s the case, we call ‘vicious circle’ on this one.
Related links:
The Swiss National Bank is pegging it - FT Alphaville
Carried away in Switzerland - FT Alphaville
When a government bond becomes a Giffen good – FT Alphaville