Jean-Pierre Danthine: Signals from the financial markets and
developments in the implementation of Swiss monetary policy
Introductory remarks by Mr Jean-Pierre Danthine, Member of the Governing Board of the
Swiss National Bank, at the half-yearly media news conference, Geneva, 17 June 2010.
* * *
As has been pointed out in the speeches of my two colleagues, reports on the economy are
quite positive and indicate a faster economic recovery than anticipated. The signals from the
financial markets, however, are less favourable and I will be talking about them in the first
part of my remarks. I will devote the second part of my comments today to developments in
the implementation of monetary policy over the last few months. These developments result
from the unconventional monetary policy measures adopted by the Swiss National Bank
(SNB) to combat the financial crisis and to ensure price stability in line with its mandate.
International financial markets experience an uncertain period
The period of calm which prevailed on international markets from spring 2009 onwards gave
way to a new phase of uncertainty in the second quarter of 2010. Since April 2010, the
climate on financial markets has deteriorated again. Share prices have fallen, credit risk has
risen and instability has increased on the major foreign exchange markets. As Philipp
Hildebrand has already stated, the return of uncertainty chiefly reflects investors' doubts
about the capacity of certain countries to service their debt. These doubts are reflected in a
significant increase in risk premia for sovereign debt in these countries, which has prompted
them to establish major cost-cutting programmes. This situation is weighing on financial
markets, despite the relatively favourable reports of economic recovery at the global level.
Indeed, current market uncertainty has reached a high level, although it remains lower than
that observed during the recent crisis. To give an example, the VIX index (which measures
uncertainty on the equity market) and the CDX index (which measures credit risk) are both
rising again. However, they are still significantly lower than at the end of 2008, i.e. at the
peak of the subprime crisis (cf. chart 1).
The uncertainty associated with the fiscal situation of certain European countries has also
triggered another rise in tension on the interbank market for US dollars. To counter this,
several central banks, including the SNB, have reactivated swap facilities in cooperation with
the Federal Reserve in order to provide dollar liquidity that may be required for the smooth
functioning of the markets. In Switzerland, the interbank market has remained calm. Indeed,
the ample supply of liquidity has reduced Swiss franc interbank rates. As can be seen in
chart 2, risk premia on the Swiss franc interbank market have also declined. They fell by
more than a half in May while, during the same period, US dollar risk premia on the interbank
market in the US rose again.
Alongside the uncertainty, investor risk aversion has grown over the last few months. As a
result, there has been a movement of capital in the direction of investments that are
considered to be more secure (flight to quality). This is reflected, for example, in a rise in the
gold price since February 2010. In May 2010, the gold price in Swiss francs reached new
heights.
The flight to quality has also had consequences for Switzerland, since our country has
traditionally been regarded as a safe haven for investors. This situation has been reinforced
by the fact that, until now, the Swiss economy has withstood the crisis better than most
developed countries. This has resulted in upward pressure on the Swiss franc, which has led
to repeated interventions on the foreign exchange market. The liquidity injected into the
market in the course of these interventions has reduced Swiss franc interest rates, in
particular for short term maturities. In addition, the yield on 10-year Swiss Confederation
bonds fell to below 1.50% in May 2010. For the sake of completeness, it should be pointed
out that the Swiss franc has not been the only currency to appreciate. The yen, the US dollar
and the currencies of the Nordic countries have also strengthened against the euro.
Investing foreign exchange reserves
As already mentioned by Philipp Hildebrand, the SNB had to implement unconventional
monetary policies in order to combat the financial crisis and avert deflation risks. This
resulted in an expansion in the SNB balance sheet, which took place in two stages. In the
first stage, during the crisis, the SNB made use of EUR/CHF swaps, while in the second
stage, when it was confronted with the appreciation of the Swiss franc, it intervened on the
foreign exchange market. As part of these unconventional measures, the SNB purchased
Swiss franc bonds issued by private sector Swiss borrowers and temporarily extended the
terms of its repo operations.
Today I am going to focus on the impact that the SNB's interventions have on its balance
sheet. In these interventions, the SNB purchased euros as well as, to a lesser extent,
US dollars. These acquisitions led to a significant increase in currency reserves, which rose
from CHF 95 billion in December 2009 to over CHF 230 billion at the end of May 2010.
The foreign exchange acquired through SNB interventions has been placed in securities. The
SNB's investment policy is founded on the criteria of security and liquidity, but also return. In
order to satisfy the requirements of security and liquidity, the SNB has focused on the
purchase of liquid instruments of first-class quality. All investment activity is carried out
according to a strategy based upon diversification, while also taking into account potentially
major but low-probability events. A further aim of this strategy is to ensure maximum
resilience of the SNB balance sheet. For the sake of completeness, let me add that, given
the accumulation of additional dollar reserves, the issuance of SNB Bills initiated in February
2009 to finance the SNB stabilisation fund is no longer necessary. Consequently, the SNB
will suspend its issuance of SNB USD Bills. The last auction will be held on 21 June 2010.
As has already been mentioned by Philipp Hildebrand, the extent of foreign exchange
interventions are leading to a higher risk concentration for the SNB. However, monetary
policy considerations remain paramount. Furthermore, we need to keep the overall picture in
mind. Thus, since our portfolio is well diversified, no loss has been recorded overall since the
beginning of the year. This is due, in particular, to investments in foreign currencies other
than euro as well as our gold investments, which also constitute one of our main sources of
risk. What is more, the important time period is the long term and over that horizon potential
exchange rate losses should be offset (at least in part) by the return on foreign exchange
investments. Finally, it must be borne in mind that the SNB has set aside substantial
provisions to absorb any possible future losses.
Transition from a liquidity deficit to excess liquidity in the financial system
The unconventional measures taken by the SNB to combat the impact of the crisis and to
avert deflation risks have led to an ample supply of liquidity to the financial system.
Therefore, we have witnessed a gradual shift from a liquidity deficit to a situation
characterised by excess liquidity. In fact, before the crisis, banks had to obtain liquidity from
the SNB in order to satisfy their minimum reserve requirements. Today, they have sufficient
liquidity to function without having to finance themselves via the SNB. This situation of
excess liquidity is of a permanent nature.
The transition from a liquidity shortage to excess liquidity does not, however, change the
SNB's monetary policy strategy, which is still aimed at stabilising the three-month Libor within
the target range set by the SNB. The implementation of this strategy has nevertheless been
adjusted to reflect the new liquidity conditions. In times of a liquidity shortage, the SNB must
supply the markets with liquidity to keep the Libor at the targeted level. If there is excess
liquidity, it must drain liquidity from the market in order to keep the Libor at the same desired
level (cf. chart 3). This situation can be compared with that of a driver going up a mountain
pass. Driving up the hill, he pushes on the gas pedal in order keep the vehicle driving at a
certain speed. On the way down, however, he must step on the brake continue to travel at
the same pace.
Monetary policy with SNB Bills and reverse repos
The SNB is not the only central bank that finds itself in a situation of excess liquidity. The
majority of central banks which have taken unconventional monetary policy measures are in
the same position. Central banks have a range of measures at their disposal to reduce this
excess liquidity. After analysing the different alternatives, the SNB decided to use a
combination of SNB Bills and reverse repos. These instruments are perfectly in line with our
monetary policy strategy. There is, however, still a range of alternative instruments available,
should there be a need for them.
Let me explain briefly how the method chosen by the SNB works. As I have already
mentioned, the SNB aims to keep the three-month Libor within a certain target range. This
rate depends on the level of liquidity in the financial markets. If there is excess liquidity, the
SNB must withdraw a certain amount to influence the level of the Libor. In so doing, it uses a
two-pronged approach: on the one hand, it issues SNB Bills with different terms. Banks or
investors who purchase these bills pay the SNB with liquid funds, which are thus drained
from the financial system. On the other hand, the SNB also makes use of reverse repos in
order to complete the withdrawal of liquidity achieved by the use of SNB Bills. In a reverse
repo, the SNB delivers securities to a bank in exchange for liquid funds, thereby absorbing
liquidity from the financial system. Reverse repos with a term of, in general, one week are
used to manage short-term liquidity. SNB Bills, on the other hand, are used to manage
liquidity in the longer term (one month or more). By combining these two instruments, the
SNB is able to determine the volume of liquidity it wants to drain from the system, thereby
influencing the three-month Libor. The SNB continues to use a three-month Libor target
range as its reference band for monetary policy.
The use of SNB Bills and reverse repos
The SNB has been
issuing SNB Bills since October 2008. At beginning of this month, a
secondary market for buying and selling these short-term debt certificates was established.
This secondary market improves market liquidity. SNB Bills have other advantages. First,
their flexible terms can be adapted to the monetary policy objectives. Second, they permit
greater flexibility and can be issued at high volumes.
The SNB has been stepping up the issuance of SNB Bills since March 2010. It currently
offers SNB bills with terms ranging from one week to three months. The total amount of SNB
Bills outstanding last week amounted to about CHF 80 billion. This made it possible to
reduce sight deposits to around CHF 70 billion. SNB Bills and reverse repos are
characterised by their extraordinary flexibility, allowing for an efficient implementation of
monetary strategy that is fully compatible with the monetary policy concept that has been
proven and tested for several years now. In employing these instruments, the SNB continues
to operate in an environment that is both familiar to and stable for its different partners. It is
nevertheless ready to adjust its monetary policy instruments quickly, should this be required
by developments in the financial markets.
BIS Review 85/2010
BIS Review 85/2010