The conservative Swiss guarantors of financial stability would prefer to avoid a repeat of the turmoil they suffered on January 15 this year. On that Thursday, the Swiss franc shot up 30 percent against the dollar and the euro after Switzerland’s central bank bowed to market pressure and abandoned a three-year cap of 1.20 francs to the euro as investors fleeing the euro crisis piled into the rock-hard currency of the wealthy Alpine state.
A strong franc is poison for Switzerland’s export-heavy economy. Thomas Jordan, governor of the Swiss National Bank, the SNB, isn’t to be envied.
His central bank is wedged between the European Central Bank and the U.S. Federal Reserve, whose monetary policies have a huge impact on Switzerland.
Even the timing of of the SNB’s next policy meeting on Thursday is difficult. It comes one week after the ECB cut its deposit rate and extended its monthly asset buys by six months, and six days before the next meeting of the Fed, which is widely expected to go the opposite way and start raising interest rates.
“The new monetary easing by the ECB was smaller than expected. That takes pressure off the SNB.”
Unlike financial markets, which were disappointed by the ECB’s smaller-than-expected stimulus, there was a collective sigh of relief in Switzerland’s financial establishment that the central bank, which dictates policy for the 19-nation euro zone, didn’t go even further.
If ECB President Mario Draghi hadn’t just prolonged the ECB’s bond-buying program past September 2016, but had increased the volume above the current €60 billion per month, the euro would probably have come under further downward pressure, and pushed up the Swiss franc. But since the ECB announced its decisions last Thursday, the exchange rate between the two currencies has remained stable at 1.08 francs to the euro.
“The new monetary easing by the ECB was smaller than expected. That takes pressure off the SNB,” said Professor Ernst Baltensberger of Bern University. The economist was the doctoral thesis supervisor of Mr. Jordan and is regarded as one of Switzerland’s leading monetary policy thinkers. “I don’t expect the SNB to lower its negative rates even further on December 10,” Mr. Baltensberger told Handelsblatt.
The United States could have a major impact too. The interest-rate differential between the 19-nation euro zone and the United States is an important determinant of the franc-euro exchange rate, as Mr. Jordan keeps stressing. If the U.S. pays more interest, European investors looking for a safe investment will be tempted to send their money back across the Atlantic rather than park it in Switzerland.
To protect its currency, Switzerland has also fought hard to essentially make itself less attractive for investors than the euro zone. That’s why the SNB consistently makes sure that Swiss interest rates are below those in the euro zone. That prevents the franc from appreciating and thereby hitting Swiss exports to the euro zone.
Since January 15, banks and large investors have to pay a 0.75 percent punitive rate when they park funds with the SNB. The ECB cut its deposit rate slightly from minus 0.2 percent to minus 0.3 percent. But this hasn’t had impact on market interest rates yet.
“The interest differential between the euro zone and the franc area hasn’t narrowed so far,” said Claude Maurer, an economist at Credit Suisse.
At the same time, Mr. Maurer said he expects the SNB will soon have to lower its negative interest rate to minus one percent. But he said he doubted that will happen as soon as Thursday’s meeting.
All eyes are on the Fed now. “The Fed is more important than the ECB for upcoming monetary policy decisions by the SNB,” said Mr. Baltensberger, the economist. “If the U.S. central bank finally launches the overdue upswing in interest rates, it will take upward pressure off the franc.” That’s because a Fed rate hike would trigger heavy capital flows into dollar assets.
There appears to be little doubt that the Fed will deliver a quarter-point interest rate hike next week, the first increase in U.S. rates in a decade.
The Fed’s benchmark rate has been close to zero for seven years, in a range of up to a quarter percentage point. But in recent weeks Fed Chair Janet Yellen has made plain that the time is ripe for a normalisation of monetary policy. News last Friday of a healthy rise in U.S. employment in November strengthened her case.
The question everybody’s asking now is how things will continue in 2016. Markets expect the Fed to keep hiking in tiny steps while some bank economists expect it to tighten the reins more forcefully. Goldman Sachs recently made that prediction.
One thing’s clear: there is no pre-set course for further rate increases. The Fed will continue to scrutinise economic data as they come in and react accordingly. Ms. Yellen has kept on stressing that monetary policy will remain very accommodative even after the hike. That’s a view her deputy, Stanley Fischer, has echoed. They clearly want to avoid scaring investors and sending markets down too far, so that the hike doesn’t put a bigger brake on economic growth than intended.
The message has got through. Jamie Dimon, the chief executive of JP Morgan, recently told Handelsblatt that the Fed was on the brink of “normalizing” monetary policy, “and not tightening.”
But how accommodating is the Fed’s policy really? In a recent speech, Bill Dudley, the head of the Federal Reserve Bank of New York, came to a slightly different conclusion than Ms. Yellen, saying current monetary policy wasn’t especially expansive. An increase by a total of one percentage point — meaning three further hikes in 2016 — would already lead to a neutral monetary policy, and as long as inflation doesn’t increase, every further hike would act as a brake on economic growth, he argued.
Mr. Dudley estimates core inflation, which excludes volatile food and energy prices, at one percent at present. That puts the Fed’s real interest rate — meaning the nominal rate less inflation — at around minus one percent. According to Mr. Dudley, the so-called equilibrium rate — at which the demand for and supply of money are equal — currently stands at zero percent, after having been two percent in past years. This equilibrium rate is the real rate at which the Fed provides the maximum support for the economy without risking an increase in inflation. If Fed rates exceed this rate, monetary policy has a slowing effect on growth.
This equilibrium rate can only ever be estimated. Mr. Dudley and other economists believe it’s significantly lower than before the financial crisis because of weak growth in productivity in recent years. The equilibrium rate depends on how much growth an economy can potentially generate — and that’s a lot lower now than it used to be.
Mr. Dudley’s calculation doesn’t just mean that the Fed has relatively little scope for interest-rate hikes. It also means that its policy is already less accommodative than it looks, and poses less risk of future inflation than it used to in the past.
Forecasts for Fed rates depend on whether one shares Mr. Dudley’s assessment that the equilibrium rate will remain low, and on whether inflation will increase at last. There are other imponderables.
But Ms. Yellen has made clear she wants to start increasing rates now to give herself monetary policy scope for the coming years. And there are no serious doubts that she will receive broad support for a hike from the Federal Open Market Committee, which sets rates, when it next meets on December 15 and 16.
If she does follow through, it will be a good day for Thomas Jordan and the Swiss National Bank.
Frank Wiebe is a New York correspondent for Handelsblatt. He focuses on finance policy. Holger Alich is Handelblatt’s Switzerland correspondent, covering the financial industry. To contact the authors: email@example.com and firstname.lastname@example.org.