Jean-Pierre Danthine: Market developments, Swiss monetary policy and
foreign exchange reserve management
Introductory remarks by Mr Jean-Pierre Danthine, Member of the Governing Board of the
Swiss National Bank, at the half-yearly media news conference, Berne, 16 June 2011.
* * *
In my remarks, I would like to examine three topics. First, I will comment on developments in
the international financial markets. Then I will briefly address the situation in the Swiss franc
money market and the implementation of monetary policy. Finally, I will talk about the
management of the foreign exchange reserves.
Developments in the international financial markets
Developments in the international bond, share and foreign exchange markets are mixed and,
as before, characterised by relatively high volatility. The relatively favourable global
economic developments and the fact that the balance sheets and the liquidity situation of
corporations outside the financial industry are in relatively good - in some cases very
good - shape are having a positive effect. By contrast, the balance sheets of many
governments reflect the consequences of crisis measures and increasing structural debt
problems. Thus, in recent quarters, the financial markets have presented a mixed picture.
Signs of an improvement in the prevailing mood have been followed by setbacks attributable
to the serious impending challenges. At the beginning of the financial crisis, these were
mainly concentrated in corporations' balance sheets. Since then, the market has increasingly
shifted its focus towards the risks associated with government debt. Such fundamental
changes in investor risk assessment influence not just the prices of the affected bonds. They
also impact on other investment categories and, therefore, as I will explain later, on the
financial markets in general.
Allow me to begin by addressing the most serious developments. The European sovereign
debt crisis is far from over. In comparison to last year, it has again worsened. Thus the credit
risk premia of euro countries with large debt burdens continued to rise; compared to the
previous year's average value, the risk premia have approximately doubled. That the debt
problem in the euro area has worsened is apparent not just on the bond markets. On the
foreign exchange market, the CHF/EUR exchange rate, in particular, reacted strongly,
attaining new all-time high levels. Since, at the same time, the US dollar was still tending
lower, the CHF/USD exchange rate also climbed to extreme levels. The weak dollar has to
do with doubts about the robustness of the US economy in the wake of diminishing fiscal and
monetary policy stimuli, as well as worries about US public debt. Since the Swiss franc also
recorded historical exchange rates against other currencies, its value, on a real and
trade-weighted basis, is now well above its long-term level.
Investor appetite for bonds considered to be secure helped to push down capital market
yields on US, German and Swiss ten-year government bonds to the level last recorded in
December 2010 of around 3% (US and Germany) and 1.7% (Switzerland). By contrast, the
risk premia for bonds of particularly burdened euro economies - namely those of Greece,
Ireland and Portugal - continued to rise. Overall, the risk premia of certain European
sovereign borrowers remain very high, and latent threats of contagion continue to exist.
In the global equity and commodity markets, the mood during recent quarters was cautiously
positive. In the equity markets, the gratifying corporate results had a strongly supportive
effect. In the US, for example, around two-thirds of the most important corporations reported
better results than were expected by the market. In the commodity markets, healthy
economic conditions - especially in the emerging countries - assisted a continuation of the
upward movement, although here, too, price volatility remained high. However, there were
also factors weighing on the markets, like the political unrest in North Africa and the Middle
East, the catastrophe in Japan and, finally, the indications of a global economic slowdown in
the markets.
To summarise, the situation in the international financial markets presents a mixed picture,
despite the fact that economic developments are relatively favourable. This reflects the fact
that the burden inherited from the economic and financial crisis continues to be very
significant.
Implementation of monetary policy
The financial crisis was characterised not least by turbulence on the money market. While
uncertainties in the international financial markets persist, the situation in the Swiss franc
money market eased last year, and has been very relaxed since the beginning of 2011. The
Swiss franc money market is still in a position of structural liquidity surplus vis-à-vis the Swiss
National Bank (SNB). Consequently, our focus is on liquidity-absorbing open market
operations. Currently, a large proportion of the surplus Swiss franc liquidity is being absorbed
through SNB Bills amounting to around CHF 110 billion and daily repo auctions (reverse
repos) of around CHF 25 billion. The volume being absorbed has not been increased over
recent months. Consequently, the total sight deposits of domestic banks have, at
approximately CHF 25 billion, remained almost unchanged. This is a significantly higher level
than before the financial crisis. It exceeds the minimum reserve requirements many times
over. As a consequence, interest rates on the Swiss franc money market are still close to
zero. Despite the fact that interest rates are still very low, the volume of activity on the
secured Swiss franc money market remains at a relatively high level. By contrast, the
volumes traded on the unsecured Swiss franc money market are still markedly lower than
their pre-crisis level. The management of the three-month Libor is, however, not affected by
this, and can still be guaranteed.
The management of the foreign exchange reserves
Allow me to conclude with a few words on the management of our foreign exchange
reserves.
First, let me stress that the increase in the foreign exchange reserves in 2009 and 2010 was
a direct consequence of monetary policy measures. It had nothing to do with the pursuit of
investment goals. With interest rates close to zero, the SNB created additional Swiss franc
liquidity through foreign exchange market interventions. This prevented the rise in the value
of the Swiss franc from leading to what at the time would have been an undesirable
tightening of monetary conditions. The foreign exchange reserves therefore surged from
around CHF 50 billion at the end of 2008 to a good CHF 200 billion by the end of 2010.
A direct consequence of our much larger balance sheet is the increase in the financial risks
associated with our foreign exchange reserves. These risks have materialised in the last
12 months, and have led to significant losses for the SNB. They hold the potential for further
losses. Just as the increase in our foreign exchange reserves was determined by the
demands of monetary policy under the exceptional circumstances that prevailed in 2009 and
2010, monetary policy considerations will continue to dictate our actions in the future. This
means, in particular, that selling our foreign exchange reserves (and buying Swiss francs) is
not an option at the moment.
Monetary policy also dictates that our currency risks not be hedged. In effect, hedging the
exchange rate risk using derivatives would be equivalent to buying Swiss francs against
foreign exchange for forward delivery. The effect of hedging on the market is thus
comparable to the direct sale of foreign currency. The only option for the SNB is therefore to
diversify its risks as efficiently as possible with a view to limiting the exchange rate, credit
and concentration risks of its foreign currency investments. The SNB had already begun
diversifying its investments in the late 1990s. The SNB foreign currency investments are
considerably more diversified than those of many other countries, with many central banks
investing their foreign exchange reserves mainly in US Treasuries, that is, in public debt titles
and in dollars. While the SNB also holds the large majority of its portfolio in the form of
government securities, it also currently holds as many as 10% of its reserves in equities and
5% in corporate bonds. In order to limit credit risk, the large majority of our public debt
holdings have the highest (AAA) or second-highest rating (AA). In effect, our current
allocation corresponds to 86% AAA-rated and 13% AA-rated public debt holdings.
The SNB diversification strategy is, however, subject to limits. These spring from the
stringent requirements with regard to the security and liquidity of the investments. Many
investment markets are too narrow, and do not meet the SNB's liquidity requirements. The
SNB's investment universe - and thus its scope for diversification - is therefore limited. The
bulk of the worldwide supply of highly rated public debt instruments is denominated in euros
and US dollars. It is thus due to the instruments available on the market that the largest part
of our foreign currency investments is in euros (55%) and in US dollars (25%). The
remainder of our investments is composed of yen (10%), Canadian dollars (4%), pounds
sterling (3%) and other currencies (3%).
Finally, taking a general and somewhat longer-term view, the following point should be
noted. The SNB's currency reserves are made up of foreign currency investments and gold.
In a risk-averse environment, losses tend to occur on foreign currency investments and
profits on gold, while in a risk-friendly environment the opposite is true. Consequently,
diversification of a portfolio to include gold and foreign currency helps to stabilise earnings
over an entire risk cycle.