Negative interest here for eternity? How would it be without her ? (April 2019)

In January of 2015 the Swiss National Bank (SNB) lifted the fixed CHF to EUR exchange rate of 1.20

and gave freedom to its national currency to run against the Euro. This led, during the first few months, to a massive fall in the price of the Euro against the Helvetic franc. The trigger for this change of strategy at the Swiss National Bank were the measures taken by the European Central Bank to lower interest rates and depreciate the Euro in order to break the deflationary trend, hoping to bring the economy back on track.

As one of these measures was the introduction of negative interest rates on the current accounts c/o the European Central Bank, the SNB was forced to react and on 22 January 2015 announced that it would have introduced negative interest rates. Logically they had to be lower than those of the Euro. It was deemed to be the only way to keep in check the appreciation of the Swiss Franc. The interest rate was therefore set at -0.75%. This measure was announced as a short-term intervention and was also brokered by the SNB. Undoubtedly, this was the best available alternative considering the situation at that time. The Swiss franc was extremely highly valued against both the Euro and the US dollar, so the Swiss National Bank only had one choice:  weaken its currency in any possible and imaginable way. This favored the many medium and small size businesses as well as many shops and department stores close to the border, which had previously seen the departure of many customers to shops across the border because of the favorable exchange rate. Because the cost of negative interest rates did not really materialize until the following months, the SNB continued, as a flanking measure, to intervene in the foreign exchange market by buying Euros, US dollars and other foreign currencies on the foreign exchange market and selling Swiss Francs. As a result, the balance sheet of our central bank ballooned to such an extent that, measured against Swiss economic performance, it is today now larger than that of the US or European central bank. The ever-increasing foreign exchange reserves in Euros and US dollars were invested on the international financial markets, especially in equities, which in turn helped to inflate the stock markets and led to a distortion of stock valuations.

Today, 4 years later, negative rates are unfortunately still at the same level. This interest expense leads to gigantic costs for the entire Swiss economy. Our pension system has been particularly suffering. Negative market interest rates led to insufficient income with which current pensions must be paid to senior citizens. Since fixed pensions can no longer be reduced by established paths and the income generated on the interest rate markets is no longer sufficient, there is a huge redistribution from the paid pension assets of the working population to the pensioners This redistribution is additionally reinforced by the increase in aging, which is also increasing in Switzerland.

The sinking income of pension funds also leads to ever lower conversion rates. In the non-mandatory compartment of pension funds today’s conversion rate of many insurance companies is already below 5%, compared to the current conversion rate, fixed by law, of 6.8% in the mandatory portion. Our concern is that, because of the persisting low rates influenced by the SNB, also the mandatory part will need to be lowered, thus eroding our future pension benefits.

The negative interest rates also had a devastating effect on commercial banks as funds had been virtually “extorted” by the SNB. In the last two years alone, the toll was approximately two billion per year! These costs are increasingly borne by commercial banks themselves which in turn are charged to their corporate customers. If negative interest rates persist for a much longer time, private customers will soon risk to further bear the burden, adding to the previous group which of already bears the costs in the pension system. As the chart below clearly shows, in 2018, the SNB transferred back to the cantons CHF 2 billion. We could say that the SNB has returned these additional funds, but in reality, these transfers do not go back to the right place, as the cantons receive them rather than the citizen. Those who have paid these costs in the form of negative interest rates feel it like an additional tax that companies and private individuals have to bear.

When will this enslavement finally stop? Klaus Wellershoff, chief economist at Wellershoff & Partner,

as well Dr. Ing. Thomas Stucki, the CIO at St. Galler Kantonalbank, think that the Swiss Central Bank should stop with negative interest rates. Of course, this repeal would make the Swiss Franc even more expensive in the short term. However, the strengthened US dollar will be able to make up for part of the weak Euro. In addition, exporting companies have become more efficient again and their breakeven point is today already at a euro exchange rate range of 1.10 – 1.15 and not at 1.20, when the price floor was introduced to the Euro.

Reversing the negative interest rate would eliminate the interest costs for companies, individuals and the pension system, which would be enormously facilitated as the yields on Swiss franc bonds would be around 30 to 50 bps higher, which in turn would lead to higher yields for bond holders. The general interest rate level would nevertheless still be very low and would only partially limit the increasingly risky investment behavior of investors, including pension funds. It would also help to replace those risky assets by others with lower risk. This would drain a lot of hot air from the bloated financial markets. In the medium term, the margins of companies would rise again, even those of the export industry and investment strategists could build again on the asset class “cash”, without paying. SNB should stabilize the CHF only with foreign exchange intervention.

So, dear Swiss National Bank, let’s stop this experiment right now. The extraordinary situation of 2015 is long gone and our country needs a fair pension system for all generations.

Gian Heim CIO, 2. April 2019