Speech
Embargo
8 November 2018, 6.30 pm
Ten years after the crisis: evolving markets and the challenges
for the SNB
Money Market Event
Andréa M. Maechler and Thomas Moser
Member of the Governing Board / Alternate Member of the Governing Board∗
Swiss National Bank
Geneva, 8 November 2018
© Swiss National Bank, Zurich, 2018 (speech given in French)
Ladies and Gentlemen, I wish you a warm welcome to the Swiss National Bank's Money
Market Event in Geneva.
Ten years ago, back in the autumn of 2008, none of us knew when or how the crisis would
end. At the time, central banks adopted a raft of measures to tackle multiple challenges in
quick succession. Having exhausted the conventional monetary policy toolkit, they turned to
more innovative approaches, cutting their short-term interest rates to unprecedented levels and
substantially expanding their balance sheets.
Today, a decade later, the worst fears have evaporated, economic growth has returned to a
robust level in many parts of the world, and some central banks have started to gradually
tighten their monetary policy. For the SNB, though, it is still too early to contemplate taking
such action. At our last monetary policy assessment in September, we decided to maintain our
expansionary monetary policy stance. Although economic developments are favourable,
inflationary pressures remain low. Moreover, the Swiss franc remains highly valued and the
situation on the foreign exchange market is still fragile.
Against this backdrop, the contours of a 'new normal' are emerging for central banks. While
there are still many significant unknowns in the political, geopolitical and economic arenas,
one thing is certain: the environment in which the central banks operate has evolved
considerably, mainly due to structural changes. Some of these changes had already begun well
before the crisis, but they have accelerated in the intervening period. I am thinking here of the
digitalisation of the economy, for example, as well as the emergence of new technologies on
the financial markets.
In this speech, I would like to outline how the SNB has had to adapt - and continues to adapt
- to make sure it is always in a position to fulfil its mandate. To illustrate this point, I want to
focus on three key markets for the SNB that have experienced major changes: the goods and
services market, where digitalisation may be influencing pricing and where we, in turn, must
remain alert if we are to fully grasp the associated dynamics; the foreign exchange market,
where the emergence of new technologies and players has led us to expand our in-house
capabilities and redouble our efforts to stay at the cutting edge of technological progress
(Thomas Moser, Deputy Head of Department III since 1 September, will give you more detail
on this topic); and finally, the money market, where structural changes are prompting us to
work on modernising infrastructure and maintaining appropriate framework conditions in
order to ensure effective implementation of monetary policy.
Evolution of the goods and services market and weak inflation
So let me start with the goods and services market and inflation developments. This market is
presenting central banks with an important conundrum: why, given that the economy has
firmed significantly since 2017, has inflation remained low in most advanced economies?
Two major reasons stand out: on the one hand, monetary policy geared to price stability has
firmly anchored inflation expectations; on the other, various structural factors linked to
globalisation may have had a moderating effect on prices.
As shows, in Switzerland inflation remained low in the early post-crisis years, due in
chart 1
particular to the fall in energy prices and strong appreciation of the Swiss franc in the
aftermath of the euro area debt crisis. Today, thanks in part to the monetary policy measures
taken by the SNB to combat the strong appreciation of the Swiss franc, inflation for imported
goods and services has returned to positive territory (cf. red bars). Furthermore, the price of
oil is trending upwards. And finally, the consumer price index in Switzerland has been rising
again since the beginning of 2017 and currently stands at 1.1% year-on-year. Nonetheless,
inflation for domestic goods and services remains moderate despite robust economic
momentum and a steadily improving labour market (cf. blue bars).
Besides these factors, monetary policymakers may increasingly find themselves grappling
with another issue: digitalisation and its impact on the level and dynamics of prices.1
Digitalisation is affecting almost all sectors of the economy, but its effects are particularly
pronounced in retail. In Switzerland, retail trade via online platforms has been experiencing
double-digit growth for some years now, while traditional retail has been declining. Last year,
online trade already accounted for some 8.5% of all Swiss retail trade.2
Digitalisation can affect price developments in a variety of ways. On the one hand, the
increased competition and greater transparency for consumers that online trade enables may
erode the pricing power of traditional retailers. This phenomenon, sometimes called the
'Amazon effect',3 can lower inflation, at least temporarily.
On the other hand, some evidence appears to suggest that digitalisation in the retail trade leads
to faster pass-through - that is to say, it increases the responsiveness of prices to shocks
affecting the economy, such as the strong appreciation of a nation's currency. Studies show
that the growth of online trade in recent years may have helped to almost double the speed of
price adjustments in the US retail industry.4 Switzerland too has seen a trend towards faster
price adjustments over the last few years.5 Thus, shocks such as strong appreciation or
depreciation of the Swiss franc could feed through to inflation more rapidly in the future. The
SNB is therefore analysing the repercussions of digitalisation in depth, in order to understand
the impact on inflation as thoroughly as possible and ensure that it is able to take action where
necessary.
As its responses both during and after the crisis have shown, the SNB has a monetary policy
strategy that has proved its worth in highly volatile circumstances. Robust and appropriate,
this framework offers the required room for manoeuvre, allowing the SNB to tolerate inflation
temporarily moving outside the range it equates with price stability, provided inflation
expectations remain well anchored.
Innovations on the foreign exchange market
As I have explained, the SNB must adapt its analysis continuously in order to understand and
anticipate changes in the goods and services market. However, the latter is not the only
market to have undergone profound changes. The foreign exchange market, too - a key
market for the SNB - has also evolved considerably since the crisis. It is here that we conduct
interventions, as required, and it is here that we actively manage our foreign exchange
reserves. The SNB has had to adapt to ongoing changes taking place on this market as well to
ensure that it is able to implement its monetary policy effectively at all times.
For the last six years, the foreign exchange market has undergone profound change in three
different but linked areas: the technology being used, the fragmentation of trading activity and
the emergence of new players.
As regards technology, the most notable development has been the shift towards pure
e-trading. Algorithmic trading, high-frequency trading, artificial intelligence and machine
learning are just some of the commonly used terms in e-trading. Over 70% of the transaction
volume in the foreign exchange spot market now takes place electronically. The shift to
e-trading has also increased the frequency of trades. As a result, information flows have risen
considerably. Close monitoring of these markets thus requires greater data processing
capabilities.
The shift to e-trading has also led to the fragmentation of trading. With new forms of
organised markets beginning to compete for the distribution of liquidity to end-users,
transaction volumes on the primary interbank market have declined, in favour of new
secondary market sites. Examples include secondary electronic communication networks,
individual banks' proprietary trading platforms and multi-bank platforms. Monitoring market
activity has become increasingly complex as the number of sites has proliferated.
Finally, the market participants themselves have changed. On the one hand, the share of
transactions being executed by traditional bank dealers has steadily declined and this activity
is being concentrated at the largest banks. On the other hand, new players have entered the
market. In particular, companies specialising in high-frequency trading have become
nonbank market makers and have started providing liquidity to end-users on a direct and open
basis. It is necessary to monitor these trends in order to understand their potential impact on
market dynamics.
What, practically speaking, do these changes mean for the SNB? Since the financial crisis and
the decline of interest rates to very low levels, foreign exchange market intervention has
become an important tool in the implementation of the SNB's monetary policy. It is thus vital
that we closely monitor structural and technological developments on this fast-paced market,
and ensure that both our resources and our skillset are up to speed. In so doing, we stay on
level pegging with market participants and optimise the desired effect when we intervene in
the market. A thorough analysis of the market allows us to achieve the best possible trading
conditions.
I would now like to hand over to my colleague Thomas Moser. He will explain in greater
depth how the SNB performs real-time monitoring of this fast-paced market.
I would like to show you in more detail how the SNB uses high-frequency data to monitor
the foreign exchange market in real time.
We first had to refine our tools and skillset to keep pace with high-speed markets. The
fragmentation of trading activity has caused a huge increase in the volume of data that
needs to be collected, recorded and processed. To perform this task, we have invested in
internal resources, especially for the analysis of high-frequency data. This gives us a better
understanding of the microstructure of the markets that we use to implement our monetary
policy.6
Let me give you a concrete example of such an analysis. On 8 February 2018, the Swiss
franc appreciated significantly against the euro in a matter of minutes. shows the
Chart 2
limit order book for EURCHF on the interbank market between 17:00 and 17:45. The red
bars represent the bid volume, and the blue bars the ask volume. The triangles denote the
transactions carried out at the bid price (in red) and ask price (in blue), respectively. For
each tick, the system records the volume on the bid and ask sides. The dark colours indicate
more volume for a given price level.
We can see that prior to 17:15, there was a liquid order book on both sides. Thereafter, a
large number of EUR sell orders were executed; this was accompanied by a drop in bid
volume and a downward revision of bid and ask prices. Price levels with high volume - as
denoted by the darker red bars on the bid side - steadily declined to end up at CHF 1.1448
per euro. After this short-lived episode, the euro gradually recovered in the minutes that
followed.
Now let's look at the trading activity and market liquidity on that day. In the two panels of
slide 3, the green curve represents the spot rate for EURCHF on 8 February 2018. The red
curve represents two different variables: in the left-hand panel it denotes the intraday
turnover for EURCHF, while in the right-hand panel it shows the bid-ask spread, which is
an indicator of transaction costs. Finally, the salmon-coloured area shows the historical
average. We can see that trading activity between 17:00 and 17:30 was above the historical
average. By contrast, the bid-ask spread widened only slightly, before swiftly returning to
normal levels. As a result, despite the strong Swiss franc appreciation, market liquidity
remained strong.
If we combine the information in these three charts, we can see that the Swiss franc
appreciation recorded on 8 February was accompanied by high transaction volumes, but
this was absorbed comparatively easily by the market. This example shows how we analyse
the microstructure of the market in real time.
But capturing micro-changes in real time is not enough to allow an understanding of the
underlying market dynamics of the Swiss franc. Rather, we need to be able to tie them to
longer-term trends, in other words a period spanning several weeks or months. Since the
beginning of the year, for instance, we have observed three risk-off events that put upward
pressure on the Swiss franc, as illustrated by the red curve in
chart 4.
First, last February, concerns surrounding a faster-than-expected tightening of monetary
policy in the US triggered a major stock market sell-off and a corresponding volatility spike
(green curve). Then, in May, political uncertainty in Italy led to a considerable widening of
the yield spread between German and Italian 10-year bonds (blue curve). Demand for
various asset classes regarded as safe havens, such as the Swiss franc, increased. Finally, in
August, we witnessed a huge sell-off of certain emerging market currencies and an increase
in their volatility (yellow curve). Fears of global contagion resulted in the franc
appreciating strongly. It remains a safe-haven currency during periods of high uncertainty.
Indeed, an analysis of the options market confirms that the Swiss franc was in demand as a
safe-haven currency during the three events described above. Risk reversal shows that
during these events, participants were prepared to pay a higher premium to hedge against
losses resulting from a steep appreciation of the Swiss franc vis-à-vis the euro than against
a depreciation. As we can see from chart 5, three-month risk reversal for the EURCHF pair
was significantly negative. Even today, risk reversal is still well below zero, indicating that
the situation on the foreign exchange market remains generally fragile.
And now I would like to hand back to Andréa Maechler.
As we have just seen, without this kind of in-depth analysis as a supplement to traditional
macroeconomic analysis, it would not be possible for us to capture the complexity of markets
simply and comprehensibly. Today, our communication on the Swiss franc is centred around
two key statements: the currency remains highly valued, and the situation on the foreign
exchange market is still fragile. By communicating our knowledge of the financial markets in
a clear and simple way, we bolster participants' confidence and contribute to the credibility of
our monetary policy implementation.
A changing money market
Lastly, I'd like to take a look at another market that has seen profound change since the crisis:
the money market. This market is particularly important for the SNB, especially with respect
to the implementation and transmission of its monetary policy.
The money market has undergone two major changes, largely driven by external factors. First,
the structure of the market has evolved, with the inexorable decline of the unsecured segment
and concomitant rise of the secured segment; this structural change has meant that repos now
take centre stage on the money market. Second - and this change is closely bound up with the
first - we observe that the framework conditions within which the money market operates
have been recast following the decline of the unsecured segment. I am alluding here to the
replacement of the Libor as the reference interest rate for a variety of financial products, both
in Switzerland and around the world.
Coming back to the first point: the drop in volume for unsecured transactions, particularly on
long-dated operations (more than one month), is a global phenomenon. It reflects the banks'
loss of confidence in conducting transactions on an unsecured basis since the beginning of the
financial crisis. This trend has not been reversed, as we can see from Activity on the
chart 6.
money market has shifted towards the secured segment - in Switzerland towards the repo
market (shown in blue). Following the substantial injection of liquidity in the wake of the
SNB's interventions, activity in this segment has also declined. However, the sizeable
liquidity surplus has not reduced volume to zero. In fact, the introduction of negative interest
on sight deposit accounts at the SNB has prompted banks to arbitrage their exempted
amounts. In addition, banks have continued to trade in repos, in order to exchange the
corresponding collateral. Collateral management tends to gain in importance in response to
ever-stricter regulation. Insurance companies are likewise active in the market, for liquidity
management purposes.
In this changing context, the money market has performed its role as a monetary policy
transmission channel to the fullest extent. Following the introduction of a -0.75% negative
interest rate on sight deposit accounts at the SNB at the beginning of 2015, the various money
market interest rates rapidly moved into negative territory, as shows. The decline also
chart 7
spread to yields on bond and credit markets.
To ensure the smooth functioning of the capital market and the effective transmission of
monetary policy regardless of the circumstances, the quality of the money market
infrastructure plays a key role. The existing money market infrastructure managed by SIX has
many advantages: for instance, it has a wide range of participants, including the SNB, who
make up a homogeneous market and interact on a shared platform. Moreover, that
infrastructure is highly automated and standardised. It is in the process of being upgraded, to
better respond to the changing needs of participants. A new repo trading platform, CO:RE,
was launched in 2016. Moreover, a new triparty agent is being set up which will offer market
participants a wide range of services and will enable a more efficient management of
collateral through closer integration with pure trading activities.
Finally, a resilient and modern repo market infrastructure is essential to allow the SNB to
deploy its entire monetary policy toolkit effectively and at any time. Indeed, the SNB uses the
same SIX platform as private participants to implement its monetary policy, by
auctioning/exchanging repos or reverse repos or even issuing SNB Bills. As you will recall,
the latter were issued at the beginning of the crisis. They proved to be an efficient and flexible
way to absorb liquidity.
I will now turn to the second point: the replacement of the Libor as the reference money
market interest rate. It should be noted that the decline in transaction volumes for the
unsecured segment of the money market involves not just the Swiss franc but all currencies.
As a result of this decline, the Libor, which is supposed to reflect the major banks' unsecured
refinancing costs, is now hardly ever based on effective transaction prices but instead relies
almost exclusively on estimates. In response, the UK's Financial Conduct Authority has
announced that it will no longer maintain the Libor after 2021. All market players will have to
make careful preparation for this.
In Switzerland, work on replacing the Libor is already well advanced, but a complicating
factor is the rate's widespread use. The national working group on Swiss franc reference rates
(NWG), which is in charge of ensuring a smooth transition, has identified SARON as the
preferred alternative solution to the Libor.
SARON has already established itself as a reference interest rate, and there is now an interest
rate curve based on SARON. It is crucial to have a SARON-based curve capable of being
used instead of the Libor curve, for price setting across the Swiss franc capital market.
Amounts outstanding on the overnight swap market (OIS) based on SARON are currently
low, but are likely to grow significantly in the future. In this connection, I would also like to
mention that the first SARON-based futures contract was launched only around ten days ago,
and traded on the Eurex platform. In the future, when products based on SARON (loans,
mortgages, etc.) are brought to market, trading volumes for the associated collateral
instruments will increase. These instruments, in turn, can be used for loan pricing.
One of the challenges involved in replacing the Libor with an overnight rate such as SARON
is how to determine forward rates that would, for example, allow the calculation of quarterly
payments on contracts. At the moment, the derivatives market is not liquid enough to provide
a prospective forward rate (i.e. one that is known in advance). This is why the working group,
at its meeting last week, opted for a backward-looking calculation method based on the
average of daily SARON rates over the period concerned.
As co-chair of the NWG, the SNB is supporting the process by providing coordination at
national level and encouraging dialogue at international level. Ultimately, though, only the
market participants themselves can ensure a successful transition. It is thus critical that they
become involved, keep themselves informed about the working group's recommendations,
and put them into practice. Participation in the working group is open to all those operating in
the market. I should add that an information session on the working group's latest activities
and on future challenges will be taking place tomorrow in Geneva.7
Before finishing, I would like to emphasise that the SNB retains its ability to steer interest
rates even without the Libor. For instance, it is currently doing so by means of the negative
interest rate on the sight deposits which the banks hold at the SNB. The disappearance of the
Libor or the transition to another interest rate would change nothing in that respect. To date,
in order to implement its monetary policy, the SNB has allowed the three-month Swiss franc
Libor to fluctuate within a range. Obviously, this element of its strategy will have to change.
The SNB will announce the requisite changes in due course.
Conclusion
Ladies and Gentlemen, to conclude:
We have seen that, ten years on from the crisis, central banks' basic mission has not
fundamentally changed. However, the environment in which they operate has evolved and
continues to do so. For this reason, it is essential that the SNB has a precise understanding of
the changes it faces, and adapts itself in response, in order to ensure the continued and optimal
fulfilment of its mandate.
To date, the SNB has been able to rely on a sound strategy and on the skills and
state-of-theart technologies that allow it to remain agile in a constantly changing world. I am convinced
that it will continue to do so in the future.
Thank you for your attention.
Board
markets
Governing
the
of
SNB
evolving
Member
the
rnate
sis:
r
ser
After the crisis, inflation in Switzerland remained subdued due to low
oil prices and strong appreciation of the CHF
SNB.
FSO,
Sources:
1 08.11.2018 Ten years after the crisis: evolving markets and the challenges for the SNB | Andréa M. Maechler and Thomas Moser | © Swiss National Bank
Low High
High
using
time
real
Bank
in
National
Swiss
©
|
market
Moser
the
Thomas
and
time
of
Tick
Maechler
M.
Andréa
|
ucture 2018
Unusually high trading activity for the EURCHF pair between 17:00
and 17:30, but robust liquidity conditions
1.160 1.160
1.158 1.158
High
High
1.156 1.156
1.154 1.154
1.152 1.152
spread
1.150 1.150
EURCHF
Turnover
bid-ask
1.148 1.148
1.146 1.146
1.144
1.144
Low Low
1.142 1.142
09:00 12:00 15:00 18:00 09:00 12:00 15:00 18:00
SNB.
EURCHF (rhs)
8 February 2018: turnover (left chart); bid-ask spread (right chart)
Source:
Since February 2017: turnover (left chart); bid-ask spread (right chart)
Since the beginning of the year, various risk-off phases have led to an
appreciation of the CHF
SNB.
Morgan,
JP
Bloomberg,
Sources:
4 08.11.2018 Ten years after the crisis: evolving markets and the challenges for the SNB | Andréa M. Maechler and Thomas Moser | © Swiss National Bank
Options market reflects the fragility on the foreign exchange market
SNB.
Bloomberg,
Sources:
5 08.11.2018 Ten years after the crisis: evolving markets and the challenges for the SNB | Andréa M. Maechler and Thomas Moser | © Swiss National Bank
Unsecured transactions have practically disappeared in favour of
secured transactions
SNB.
SSX,
SIC,
Sources:
6 08.11.2018 Ten years after the crisis: evolving markets and the challenges for the SNB | Andréa M. Maechler and Thomas Moser | © Swiss National Bank
Efficient monetary policy transmission, even with a low volume of
transactions
SNB.
Bloomberg,
Sources:
7 08.11.2018 Ten years after the crisis: evolving markets and the challenges for the SNB | Andréa M. Maechler and Thomas Moser | © Swiss National Bank