Starting 22 Jan 2015, the Swiss National Bank will charge banks 0.25% to deposit overnight funds. This move will push the 3-month Swiss franc Libor rate, currently in a Fed-like range from 0% to 0.25%, into negative territory. And it is designed to prevent the Swiss National Bank from having to engage in foreign currency intervention in order to prevent the Swiss franc from appreciating beyond its red line of 1.20 francs to the euro. Some brief thoughts below
Not everyone is focusing on this story. But I think it’s significant because of what it says about the economic monetary environment we are in and what it says about the interconnectedness of the global financial system.
The Wall Street Journal gives a great primer on why the Swiss were forced into this move and I recommend you read their take here. The move is not unexpected, however. On Saturday I tweeted about its coming based on an article I read in the Swiss daily NZZ.
Swiss National Bank hasn’t ruled out negative rates – pass on to customers – Mit Strafzinsen gegen den Schuldenturm https://t.co/KadeyGUvgj
— Edward Harrison (@edwardnh) December 13, 2014
If the SNB wants to hold 1.20 to the EUR, they could be forced to mimic ECB rate policy, which means deposit tax gets passed on
— Edward Harrison (@edwardnh) December 13, 2014
Now the Swiss are saying this is the best of a couple of bad options. They could have continued to intervene in the currency markets, buying up euros to defend their 1.20 cross rate. Or they could simply mimic ECB policy to keep the peg. Think of this like the Dutch central bank’s moves pre-euro, where the Dutch always mimicked the German policy moves in order to keep the Guilder in a tight band with the Deutsche Mark.
NZZ mentioned the Danish move to negative rates as a model here (link in German). NZZ writes that Denmark has been a part of ERM II since the euro was introduced in 1999, given that the Danes voted no to the euro but the Danish government wants the option of joining the euro at a later date. The currency band is only 2.25% and that means that the Danes are in effect a part of the eurozone from a monetary sovereignty perspective. To the degree they want to keep the 2.25% band, they are forced to mimic ECB policy actions. And if their economy is weaker than the eurozone, as it was at points due to the collapse in Danish house prices and Danske bank’s exposure to other markets like Ireland and the Baltics, then the Danes would have to be even easier than the ECB.
NZZ says the Danish problem was not just economic weakness but rather Danish krone safe haven status post-Euro crisis. So in July 2012, they imposed a deposit tax of 0.2% for banks with reserves at the Danish central bank. And this caused the influx of capital from the euro that stopped as soon as the deposit tax was instituted. Think of the tax as a hot potato with hot money looking to get rid of it by fleeing the krone for other safe have n currencies (like the Swiss franc)
Source: Neue Zürcher Zeitung
Eventually, the Danes reduced the deposit tax to 0.1% and then eliminated it altogether. NZZ calls the action a success, given the aims of the Danish central bank. Of course, it was not a success in terms of its impact on credit growth. We also know that negative rates have been passed on to customers in Germany (link in German) and more big banks like Commerzbank are poised to pass on the tax. So I look at this policy as deflationary.
Of course, this is also just beggar thy neighbour policy because the Swiss are simply reacting to the influx of hot money due to the Russian currency crisis that is the direct result of a strong dollar and the drop in oil prices. So, now the Swiss are on the same page that the ECB is on, with its negative deposit rate. And perhaps this means the Danes will have to go negative again as well. Where will the hot potato go next? Given the crash in the Norwegian krona due to falling oil prices, the logical conclusion is the Swedish krona. And here again, we may see negative rates.
I think this development is significant because it underlines the limits of monetary policy in a deflationary environment. We are seeing a competitive currency devaluation tactic through extremely low interest rate policy. And to the degree that leaves the US as the odd man out, we should expect a strong dollar, weakness in commodity prices and oil, and pressure on emerging markets, where external borrowing is large.
Janet Yellen told us at her press conference yesterday that the Fed is poised to hike rates in 2015, unless the US economy falls out of bed. And she made no indication that the ongoing currency wars were a deterrent to the Fed’s doing so. Given her press comments, I believe the Fed is on hold in the January and March meetings and is also very unlikely to hike rates in April as well given the lack of a formal press conference. However, a policy change that signals a rate hike is imminent is certainly possible in April, such that hikes can begin in June already.
This is just a baseline. Everything is data dependent. And the Fed may still not hike if the US economy suffers due to the turmoil that could be created by high yield and leveraged loans. But for now, it looks like the fundamentals supporting a strong dollar are in place. And this will be a major driver of market action going forward. With monetary policy ruling the roost, don’t expect the intrinsically deflationary dynamics to change either.