SNB in a Pickle


An absolutely wonderful story came out today. The issue is the Swiss National Bank (SNB), its policy of pegging the Swiss Franc to the Euro at 1.200 and the huge reserve increase this has caused. More broadly, this is a story of Central Banks, their inventions in the markets, and the negative blow back results that these interventions cause.


This matter has been discussed in a number of newspapers/emags:


1) FTAlphaville

2) Telegraph

3) NZZ

4) WSJ


A quick summary of this fast moving story:


Standard and Poors (S&P) came out with a paper that said that the SNB had bought Euro 80Bn of core EU country bonds the past few months. S&P went on to blame the SNB for the unusual activity in the EU bond market that followed. Two-year debt instruments of Germany, Austria, Netherland and Finland went into negative territory. At the same time, bonds in Italy and Spain tanked. S&P flat out point the finger at the SNB:


SNB bond-buying is "exacerbating" the gap between borrowing costs for stable countries like Germany and the rest of the 17-nation euro zone.


Some perspective on this. What is the largest single economic threat the globe faces today? The clear answer is the funding market in the EU. Extraordinary steps have been taken by the ECB to contain the problems. More extraordinary measures are being introduced over the next few months. In spite of all that has been done, it is by no means clear that the problems can be contained. If they are not contained, the global economy is headed into a very nasty spell. And the Swiss National Bank is adding to the problem. According to S&P, its actions are directly undermining the entire global financial system.


In an extremely unusual move, the SNB fired off a response to the S&P report within hours of it being issued. Not surprisingly, the SNB denied all of the accusations by S&P:






I think this was a very dumb move by the SNB. By issuing a denial, it has opened the door. I (and dozens of others) are all going to cry:


“Prove It!”


The SNB does not break out its bond holdings. The numbers are bunched with central bank deposits. At this point no one knows if S&P is right in its assertions about the SNB bond portfolio. But that doesn’t really matter. If the SNB was loading up on deposits at the Bundesbank, it had the same consequence as direct purchases of government debt; it drove interest rates down. In this case rates went below zero in Germany while they soared in Spain.


The S&P report is an accusation that the SNB facilitated capital flight from the periphery to the core. By its actions, the SNB exasperated the problems. This is a very serious charge. I don’t think we have heard the last of this. The SNB has to step-up and prove that it is not contributing to the monetary problems in the EU. A formal announcement has to follow. Information has to be provided that attempts to blunt the S&P accusations. I believe that another SNB response is likely, as S&P has called its bluff. After the SNB refuted the information, S&P quickly came out with a response that they were standing by its numbers:


We stand by the conclusions of our report. We believe the assumptions underpinning our analysis are reasonable.


I don’t think the SNB can prove what it wants to prove. I think the evidence will show that the SNB absorbed huge amounts of capital flight from the south, and then passed it along to the north.


There is a lot at stake here. The conclusion from the SNB affair is that Central Bank policy in one country has negative consequences to other countries. This is an old story. But this time the EU is faced with a big problem with Switzerland. They are going to the mats to save the Euro, and the Swiss are scrambling their eggs. Something has to give.


The solution is simple. When the SNB gets another E10Bn from Spain or Italy, they have to put the money back into the bond markets of the countries where the money came from. That would address the EU complaints that will be forthcoming. Of course, that would put the SNB in a pickle. I don’t think the SNB (or the Swiss people) is willing to buy Spanish sovereign debt. The “Peg” policy would have to come into question under these circumstances. I don’t think the Swiss will fund Spain.




I have one gripe with the S&P report. It said that the issue with the SNB was “unnoticed”:


Largely unnoticed, Switzerland’s decision to stem the appreciation of the Swiss franc has led to a de facto recycling of funds from the eurozone periphery to its core, via the Swiss National Bank (SNB).



Unnoticed you say? I said exactly what S&P said today way back on August 7: (Link)


The SNB invests its hoard of Euro reserves in short-term German government paper. They have avoided holding their reserves in debt instruments of Italy and Spain. This has influenced market rates in Germany; two-year yields have been at or below zero for months as a result of the Swiss. This has mucked up the European bond markets as it results in a huge spread between German and Spanish yields. The Swiss intervention is adding to the stress in Euro funding markets.


Izabella Kaminska, at FTAlphaville, said much the same on September 7. (Link)


You can’t get no respect.