Swiss economy entering new territories

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Samy Chaar, chief economist at  Lombard Odier comments on the outlook for the Swiss economy.

The decision made by the Swiss National Bank on January 15th to end the currency floor implies that growth and inflation will slow in Switzerland. Nevertheless, the Swiss economy has a long history of coping with a strong currency and Switzerland’s entrepreneurs have learned to adapt and to live with this.

However there is no historical precedent for rates falling into negative territory. And while we know the impact of the US Federal Reserve’s monetary easing, the implications for negative rates announced by the Swiss National Bank are unknown.

Negative rates can, in particular, handicap the smooth functioning of interbank markets and credit. There’s a possibility that Swiss banks won’t be able to cover their rate risks and so will be less willing to lend. That may dry up credit and slow a Swiss economy already weakened by the strength of the Swiss franc.

It is a fact that the fall of interest rates into negative territory puts the all Swiss economy on new ground. Looking at Swiss monetary data since 2013 and in particular M3, which includes commercial banking flows, we can see that bank-financed economic activity has stalled. Hence fears for Swiss economic activity and the need for the Swiss National Bank to think twice before acting again.

On the basis of the Swiss National Bank data published three-times a month at the International Monetary Fund, we estimate that the Swiss central bank bought 3.4 billion Swiss francs of currency reserves in April. In comparison, it intervened to a value of 61 billion Swiss francs in January when the floor was abandoned and to a level of 15 billion Swiss francs in March. Given that the Swiss National Bank’s margin for manoeuvre is very limited, we’re tempted to think that it may continue to make only small and regular interventions.

Government bonds have been affected by the “reflation trade” witnessed at the end of April. Interest rates have been experiencing sharp moves upward in spite of accommodative monetary policies across the board.

In these conditions, we maintain our significant underweight in government bonds, preferring US Treasuries (medium-to-long end of the curve) to core Swiss or Euro bonds and short durations. The current bear-steepening configuration on the US yield curve may soon bring yields back to attractive levels. We continue to favour corporate credit issuers (both developed and emerging) in a bond pocket.

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