As expected, in its December monetary policy assessment, the Swiss National Bank (SNB) left its target range for the three-month Libor unchanged at 0.0 to 0.25% and reaffirmed its commitment to the 1.20 floor on EUR/CHF. As usual, the Swiss franc (FXF) barely responded to the announcement.
Two things stood out from the statement: a lowered forecast for inflation and several references to increased risks in financial markets.
The SNB reduced its inflation forecasts for 2014 and 2015 by 0.1 percentage point. In absolute terms this seems insignificant but relative to the already low forecasts for inflation, this reduction is significant. The SNB now expects inflation to run at 0.2 and 0.6% in 2014 and 2015 respectively and sees no inflation risk in the economy. This change reverses the SNB's slight hike to 2014 inflation expectations from the September policy statement. The SNB cites lower inflation in the euro area and lower oil prices for its forecast. I think this forecast confirms the rather subdued growth prospects for the euro area in the coming months. The SNB describes euro area growth as "lacking momentum."
The SNB tends to bias on the side of caution and wariness in its statements, especially given its concern with the over-valued Swiss franc. Thus, it is not surprising to see the SNB directly cite concerns with downside risks. However, the tone in the December statement is definitely one of heightened concern from the September statement. In the current statement the SNB states the following:
"…uncertainty about the continued recovery of the world economy remains high. In many advanced economies, low interest rates and high government indebtedness are constraining room for manoeuvre in economic policy and making the global economy prone to shocks. The forthcoming assessment of banks' balance sheets in the euro area as well as the further course of monetary policy normalisation in the major currency areas could lead to noticeable spikes on international financial markets."
I can only assume "noticeable spikes" means increased volatility accompanied by substantial sell-offs. The SNB is now concerned that little buffer exists with policymakers to deal with fresh shocks to the economy. This of course somewhat contradicts the statements from the Bank of England, the ECB, and the Federal Reserve.
In September, the SNB was a bit more charitable:
"The risk of less favourable global economic developments has decreased somewhat compared to the last quarter. Nevertheless, structural problems in Europe persist, which could cause new tensions on the markets…In addition, sudden changes in expectations on the further course of monetary policy in key currency areas could lead to increased volatility on the financial markets."
Note the change in focus now from market expectations of changes in monetary policy to actual changes. The SNB is essentially anticipating the impact of a first step toward normalization for U.S. monetary policy and the likely fall-out.
Missing from the September statement is the following outright warning in the December statement: "given the vulnerable economic situation abroad, downside risks still prevail for Switzerland."
Both statements ended with commentary on Switzerland's red hot real estate market. In the September statement, the SNB worried that existing imbalances in the real estate market could get worse. However, the SNB saw reason for a sliver of optimism:
"There are however, some signs of an easing. The price growth in some segments of the real estate market slowed somewhat in the second quarter. Mortgage growth was also slightly lower in the first half of 2013 than in the previous year."
This optimism was missing in the December commentary on the real estate market:
"In an environment of persistently low interest rates, the danger of a further build - up of imbalances on mortgage and real estate markets remains considerable. For this reason, the SNB continues to monitor the situation very closely, and regularly assesses whether the countercyclical capital buffer should be adjusted."
Mentioned in the September statement but not in the December statement was the observation that mortgage lending was climbing more rapidly than GDP and that increasing real estate prices are rising from a high level. In the September statement, the SNB simply stated it was monitoring the situation closely. The SNB now seems to have taken a small step closer to action (perhaps encouraged by the actions the Bank of England has done to remove extraordinary supports to its real estate market?). I interpret this to mean that risks in the real estate market have notably increased. Of course, part of the problem is that ultra low interest rates are facilitating increasing prices in an environment where the Swiss are probably more reluctant than usual to invest outside the country.
For additional context on Swiss real estate market, see the "UBS Swiss Real Estate Bubble Index." For the third quarter, UBS increased its index from 1.15 to 1.20, placing the Swiss real estate market firmly in the lower portion of "risk" territory with the following observation: "Residential real estate prices and mortgage debt continued to grow much more strongly than economic output and household incomes. The risks have thus risen further." The SNB seems to be confirming (or using?) the assessment from UBS.
For context, here is a chart of the bubble index since the early 1980s. Notice that the Switzerland has not been in bubble territory since the late 1980s and the current run-up has been sustained since the depths of a slump in 2001.(click to enlarge)
In 2013, the Swiss real estate market entered "risk" territory for the first time since the post-bubble contraction in the early 1990sSource: UBS
I have not paid much attention to the Swiss franc in the last half of 2013, only occasionally making trades, mostly short. I am now firmly short the franc. I have been surprised at its stubborn strength along with the stubborn strength in the euro (FXE). I would have expected the franc to ease up in conditions of euro strength. Instead, the two have largely moved together since June and in December the franc has actually notably strengthened against the euro….meaning the franc has been extra strong against almost all major currencies this month. I fully expect this strength to reverse in coming weeks or months.(click to enlarge)
After a volatile start to the year, EUR/CHF has settled into a tighter range in the past 6 months.Source: FreeStockCharts.com
Be careful out there!
Additional disclosure: In forex, I am short Swiss franc and net short euro