Jean-Pierre Danthine: Market volatility, Swiss National Bank liquidity
measures and foreign exchange reserves
Introductory remarks by Mr Jean-Pierre Danthine, Member of the Governing Board of the
Swiss National Bank, at the end-of-year media news conference, Berne, 15 December 2011.
* * *
I would like to address three main issues today. These are the acute market volatility
experienced this summer, the impact of the Swiss National Bank's (SNB) liquidity measures
and minimum exchange rate upon our money and foreign exchange (FX) markets, and the
management of our FX reserves.
Acute market volatility
The second half of 2011 has, until now, been marked by an extraordinary degree of
uncertainty. Volatility on the equity, bond and foreign exchange markets has increased
markedly, reflecting investors' concerns about the softening of global growth, the European
sovereign debt crisis, the US debt ceiling crisis and the resilience of the international banking
system.
Signs of this acute volatility abound. Allow me to highlight three recent examples. Firstly,
between July and early August, the VIX Index, a measure of the volatility of the S&P 500,
abruptly doubled. Secondly, the MSCI World Index, a measure of the state of global equity
markets, decreased by almost 20% between early July and late September, rebounding in
October, only to fall again afterwards. As concerns about bank solvency and credit risk
increased banks being at the heart of the crisis the benchmark MSCI World Banks Index also
fell by over 25% between early July and late September. Thirdly, as concerns over the
security of corporate and government bonds grew, the premia investors have had to pay
against bond defaults have increased very significantly. The perceived decrease in the
creditworthiness of key European companies and Western European sovereign bonds was
highlighted by the very sharp rise of several benchmark credit default swap (CDS) indices for
these markets.1
The foreign exchange market has been of particular concern to the SNB, as the Swiss
franc's safe haven properties and the growing dearth of alternative "safe" assets led to
massive movements in our currency, which required the SNB to act.
In early August, the real effective exchange rate of the Swiss franc peaked at an estimated
level of almost 40% above its post-1990 long-term average.2 The extent of this deviation was
very rare, in historic terms, as the previous high point, at the end of 1995, was only 12%
above the same long-term average. Since the introduction of the euro in 1999, the volatility of
the EUR/CHF exchange rate has averaged approximately 5%.3 In August it rose to almost
30%. As chart 1 shows, three of the largest ever daily negative movements in the EUR/CHF
exchange rate also occurred in this period. Since the introduction of the minimum exchange
rate on 6 September, EUR/CHF volatility has fallen below 10%, though it remains high from a
historical perspective.
The introduction of the minimum exchange rate also had an impact on some of the dynamic
properties of the Swiss franc. As the red bar on the left side of chart 2 suggests, there was
previously a positive correlation between the movements of the Swiss franc and those of risk
indicators such as the VIX Index, i.e. investors tend to buy Swiss francs when perceived risk
increases. In the same vein, the blue bar on the left of the chart shows that the correlation
between the movements of the Swiss franc and those of risky assets, such as the equity
shares on the MSCI World Index, has historically been negative. In other words, negative
market developments have often been accompanied by a rising Swiss franc. Intriguingly, as
the right side of chart 2 shows, the introduction of the minimum exchange rate appears to
have had a significant impact on these correlations.
The SNB's implementation of monetary policy: liquidity measures
On 3 August, the SNB started to implement liquidity measures against the massively
overvalued Swiss franc. Let me provide some further information on these operations. That
day, the SNB announced that it was narrowing the target range for the three-month Libor
from 0.00-0.75% to 0.00-0.25%. It also stated its intention to expand sight deposits at the
SNB. These were subsequently increased from around CHF 30 billion at the beginning of
August to over CHF 250 billion by the first week of September.
The SNB used a range of well-established instruments to effect this extraordinary increase in
the supply of liquidity to the Swiss franc money market, as chart 3 shows. Firstly, reverse
repo operations were discontinued. As a result, outstanding reverse repos fell from CHF
26 billion on 3 August to zero a week later. Secondly, the SNB stopped renewing SNB Bills
that fell due, and later started to repurchase those that remained outstanding. While these
amounted to some CHF 110 billion at the end of July, this figure gradually decreased to
below CHF 45 billion by the end of August, reaching some CHF 20 billion by the end of
November. Thirdly, to further boost liquidity, on 10 August the SNB also started to employ
foreign exchange swaps. These amounted to approximately CHF 80 billion by the end of the
third quarter. Fourthly, the SNB again resorted to conducting repo operations, which provided
the Swiss franc money market with approximately CHF 18 billion of liquidity in August and up
to around CHF 33 billion in November.
These exceptional liquidity measures exerted downward pressure on interest rates. In line
with the goals stated in the SNB's announcement of 3 August, the three-month Libor fell from
17.5 bp on 2 August to a low of 0.3 bp on 5 September, as chart 4 shows. It is now hovering
around 5 bp, though it is worth noting that limited volumes of unsecured trades are being
conducted in the present environment. The significance of the three-month Libor remains
unchanged, however, as reflected by the fact that all money market interest rates are
currently close to zero, as is the Swiss franc Libor itself.
Since early August, the Libor futures yield curve has also decreased sharply, with its March
2012 maturity reaching -0.5% on 18 August. That day, the entire curve for the period up to
September 2013 also lay below zero. The three-month rate implied in the price of EUR/CHF
swaps reached a low of -1.5%4. From a foreign investor's standpoint, such interest rate
conditions make the Swiss franc and its money market less attractive, as intended.
The downward movement of interest rates also affected the short-term borrowing costs of the
Swiss Confederation. Since the end of August, the yields from money market debt register
claims5 have moved into negative territory. On 23 August, the yields from six-month auctions
decreased to -1%, and on 30 August, the yields from three-month auctions went down to -
0.75%. At recent auctions, both yields were still negative.
It is interesting to note that these liquidity operations may have affected more than just
current and expected short-term rates. After the SNB's 17 August announcement, the rates
of two-year Swiss government bonds briefly moved below zero, and the yields of longer-term
Swiss government bonds also decreased significantly. While the yields on other long-term
government bonds which are generally considered safe also followed similar patterns, it is
nevertheless striking to observe in chart 5 that in the wake of the SNB's liquidity measures in
August, ten-year Swiss government bond yields experienced their largest declines since
1995.
The interest rate and liquidity measures taken by the SNB in August naturally preceded and
prepared for the introduction of the minimum exchange rate, in case it proved necessary.
The SNB will continue to keep liquidity at exceptionally high levels, but has decided not to set
a specific target level for sight deposits at present.
Management of the foreign exchange reserves
In the context of the minimum exchange rate, there has been renewed interest in the
management of our FX reserves. Let me repeat here that our investments are subject to the
primacy of monetary policy and implemented according to three criteria, namely, in order of
priority: security, liquidity and returns. The SNB has to bear the risk associated with
exchange rate fluctuations, as any hedge would be equivalent to buying Swiss francs against
foreign currencies. The SNB has therefore emphasised the importance of diversification and
limiting the concentration risks of our foreign currency investments.
Today, 53% of the SNB's FX reserves are invested in euro-denominated securities. This is in
line with the share of Swiss exports to the euro area, and only five percentage points more
than our allocation three years ago, though the size of our FX reserves, excluding swaps,
increased from CHF 50 billion in 2008 to over CHF 225 billion by the end of September 2011.
In order to promote further diversification, in 2010 the SNB added four new currencies to its
reserves, namely Australian and Singapore dollars, Danish krone and Swedish krona. As a
result, in addition to euros and these four currencies, the SNB's portfolio is now composed of
26% US dollars, 9% Japanese yen, 5% pounds sterling and 4% Canadian dollars.
Central banks generally have large holdings of government bonds due to their need for
liquidity. As is widely known, in recent months the ratings agencies have been reviewing or
have downgraded the credit ratings of many sovereign bonds. Despite this turn of events,
approximately 96% of all our investments in fixed-income assets are rated AAA or AA. In
closing, I would like to emphasise that we are actively exploring and monitoring new asset
classes and currencies in developed and developing markets. The aim of this process is to
continually reduce concentration risks and to further diversify the SNB's FX reserves.
4 BIS central bankers' speeches
BIS central bankers' speeches 5