17-18 December: Negative Swiss Rates; FOMC Shows Resolve Despite Risks; Russia Goes Full Frontal Amid Crisis

SNB becomes second central bank to impose negative rates

Bottom line:

  • SNB NIRP motivated by recent risks and market volatility causing fund inflows into CHF assets, mostly spurred by the CBR's 17% rate;
  • Increasingly dovish ECB hence the tit for tat monetary policy in pegged FX regime;
  • To signal to markets that SNB is determined to hold its floor even amid headwinds to its policies;
  • Market commentators skeptical of lasting impact to keep CHF weak

It just keeps coming. In this week alone we have already seen 4 central bank events starting with Russia's immense 6.5% rate hike and other policy accessories that eventually led to the chaos we saw on Tuesday; the ECB then dropped hints that it might extend its QE to sovereign bonds instead of the covered securities it currently purchases; the the planned FOMC statement and press conference with the chair woman yesterday; and then the SNB (Swiss national bank) unexpectedly cut its deposit rate.

Just after 2 past midnight in New York, the SNB's governing council sent shockwaves across the markets by imposing a -0.25% interest rate on its sight deposits effective January 22 next year. Its new deposit rate will affect deposits places at the SNB as reserves that met the amount of 20x its minimum reserve requirement (therefore affecting mostly larger deposits). Besides the headline decision, the bank also widened the target range for 3m LIBOR from the previous 0-25bp, to -75bp-25bp (increasing the range from 25bp to 100bp); this loosens some of the tightness in interbank lending market.

The Swiss National Bank (SNB) is imposing an interest rate of –0.25% on sight deposit account balances at the SNB, with the aim of taking the three-month Libor into negative territory. It is thus expanding the target range for the three-month Libor to –0.75% to 0.25% and extending it to its usual width of 1 percentage point. Negative interest will be levied on balances exceeding a given exemption threshold.

The SNB reaffirms its commitment to the minimum exchange rate of CHF 1.20 per euro, and will continue to enforce it with the utmost determination. It remains the key instrument to avoid an undesirable tightening of monetary conditions resulting from a Swiss franc appreciation. Over the past few days, a number of factors have prompted increased demand for safe investments. The introduction of negative interest rates makes it less attractive to hold Swiss franc investments, and thereby supports the minimum exchange rate. The SNB is prepared to purchase foreign currency in unlimited quantities and to take further measures, if required.
— Swiss National Bank

The motivation for the SNB's surprise actions is clear to many market participants. Namely, the SNB had acted because it was facing mounting difficulties in holding the 1.2 floor on its  EURCHF peg. Russia also had a major role to play, although this attribution is somewhat obscured.

The very recent broad based sentiment of risk aversion stemming from the rapidly developing crisis in Russia and major oil producing nations in particular has inexorably led to significant fund outflows from risk assets (which includes EM and to a lesser extents DM equities, lower grade credit and bonds, EM FX and FX strongly tied to energy prices, and commodities in general) and into safe havens (including stronger DM sovereign debt). This has evidently bid the CHF up significantly in the previous weeks, straining the SNB's abilities to support the floor given the previous limits on the bank's measures.

For readers who are lost, the SNB married the Swiss franc (CHF) to the Euro (EUR) late 2011 because the CHF was overly sought after and therefore overly expensive against most other currencies including the Euro and US Dollar. This brought to CHF to a high of 1.0070 against the EUR to a low of 1.2650 in mid-2013 (a 2500 pip swing). The SNB has been conducting unsterilized programs of reserve creation, swapping CHF for EUR with banks and financial institutions at ridiculously low spreads, thereby suppressing the value of the CHF against the EUR and also against other safe haven currencies such as the then Yen, and greenback.

This move indicates that the SNB is determined and fully willing to defend the 1.2 floor in EURCHF and continue to maintain its posture of moderating international inflows into CHF based assets. A few months ago, market participants were speculating that the Swiss referendum on the controversial topic of re-monetizing gold rather than the Euro would gain positive momentum and eventually lead to an affirmative vote, forcing the SNB to abandon its Euro peg. This speculation has brought the EURCHF from 1.2165 to a few pips above 1.2 today.

The Swiss gold referendum failed to hold, but that didn't put upward pressure on the EURCHF. The problem was the market doubted the SNB's ability to defend the peg, especially since the ECB had already been introducing negative deposit rates for a new months then and was conducting coveted bond purchases and its TLTRO. The bottom line is the the ECB was implicitly weakening the EUR, making it harder for the SNB to follow through on the peg, as the steady downtrend in EURCHF illustrates. The SNB had to act as EURCHF got uncomfortably close to breaching its mandated floor.

As drastic as the SNB's actions may seem,  it remains an open question as to how effective its measures will be and if the SNB continue to rely on FX interventions to defend the peg. What it does highlight is the bank's resolve in maintaining the lower bound for the CHF against the EUR.

Traders and commentators are already expressing their their reservations. “This is not the magic bullet, but will buy them time,” said Peter Rosenstreich, head of market strategy at Swissquote in Gland, Switzerland. “This will relieve pressure from the floor in the short term, but not in the long term.”

According to the SNB, the measure is aimed at making investments into CHF less attractive. Although it is only banks that will have to pay the negative deposit rate, banks will pass on, to some extent at least, the negative rates to customers. It is noteworthy in that respect, that some German banks - in response to the ECB's negative rates - have also started charging some clients negative deposit rates. This move isn't unprecedented in this sense.

The initial reaction by markets: Risk bid; EURCHF spiked 80 pips but has retraced 40% of the move; CHF weaker against most majors; gold mostly unchanged.


FOMC narrows policy language as expected

Bottom line:

  • FOMC states whatever was expected without much additions and alterations, but fails to address key issues;
  • Why the rush? QE is history, and uncertainty is right ahead. Why would a sensible person risk it in a skewed environment? The members haven't addressed this yet;
  • Consumer expenditures were not talked about, all they said was economic activity continues to improve. Too vague. Consumer will be a key driver for growth in 2015;
  • Policy normalization will be data dependent, prices more eyed than before;
  • Statement shows resolve to stick by mandates despite sour markets

The "most important meeting" of the FOMC has come and gone, leaving little fanfare about the Fed's future policies regarding its highly anticipated debut rate hike after 7 years of ZIRP.

The S&P had its best day of 2014 after the FOMC maintained its posture on being data dependent with regards of when and how much to start raising the fed funds rate. The "considerable time" phrase was not entirely removed from the statement, but "patience" was used in preference; markets took this as a slight development towards policy normalization. The statement continued to praise the resilience in the labor market after months of positive surprises and revisions to various job data including the NFP which recently printed an impressive figure above expectations.

Regarding the timing of the first rate hike, reluctance to eliminate the protracted element effectively rules out a hike in 1Q15 and focuses attention in the second quarter of next year. The statement also seemed to harp on prices, which makes the 2% threshold ever more important. This is something I have been saying for the entire year; a strong labor market ensures that there will be no further measures of asset purchase, but prices will the the key determinant of when the zero bound is lifted.

I very recently shared why we should be worried about price declaration and not otherwise, making me doubt the market's general consensus on a mid-2015 hike. As long as input prices such as those of materials and energy (low prices of oil result of a new paradigm vs. a cyclical trough) remain low, I'm maintaining my posture on the Fed's ZIRP; unless of course the FOMC decides to risk it and raise rates before the 2% inflation threshold is fulfilled.

The statement did touch on lower energy prices and its impact on prices, but the general feel of the message was mixed at best and gave both sides a few points each. Hawks argue that although lower energy prices have impacted shorter term inflation, the longer term survey-based expectations continue to be stable and they see prices rising around 2% by 2016. Readers will know that I completely disagree with this stance, especially on relying on survey-based metrics for expectations. The hawks also posit that lower energy prices will only have a "transitory" impact on prices. Doves on the other hand however cited the downgrade in forecasts to the core reading to 1.2%-1.3% this year (from 1.5-1.7%) and 1-1.6% in 2015 (from 1.6%-1.9%).

Also noteworthy was yesterday's CPI negative print of -0.3% sequentially (exp. -0.1%) and 1.3% annualized (previous 1.7%) mostly attributed to slump in energy. The core measure was unchanged at 0.1% over the previous month. The FOMC's inflation mandate looks at the standard price basket, and doesn't not exclude effects fluctuations in food and energy prices. The expectations of yet lower energy prices in December even as winter demand picks up will pose as a downside risk for prices. This is nothing new to realists, but the hawks need to be very weary of the real risks involved in tightening policy too soon.

Meanwhile, the all important dots point for the Fed funds rate were lowered, again suggesting that disinflation already has a foothold on voting members. The Median forecast now sits at 1.125% for 2015 (down from 1.375%) rising to 2.5% in 2016, down from 2.875% in the previous forecast.

This statement lifted markets to close at their strongest daily change in a year and was partly to due with the underlying market structure. The most important takeaway is that central banks like the Fed have far from lost their omnipotence in dictating the prices of financial assets; central banks are to the markets what judges are to courts. We cannot let this slip our mind.


Central bank of Russia goes bonkers with 7 key measures to quell rout

This week has been all about Russia, the ruble (or rubble), President Vladimir Putin's address, and other Russian memes. For the last 4 days I've been updating readers on the very dire situation and why Russia despite all its reputation for being a bear (no pun) was and continues to be on the cusp of a serious decline. After more than a year since the Ukrainian protests broke out in Kiev, and more than 4000 fatalities directly linked to the crisis, Russia is finally feeling the full brunt of all those financial sanctions and isolationist treatment it has gotten from the West. The new energy paradigm was a turbocharger that fanned the already ardent flames, expediting Russia's fall.

A day before Putin was scheduled to hold his annual press conference on national TV, the CBR revealed 7 drastic measures that fell nothing short of intimidating, to Russian bears (much pun) that is. The measures range from recapitalization of Russian banks, to banning the mark-to-market valuations of credit instruments, all with the purpose of damage control and to retain that last iota of confidence left in Russian markets following their collapse.

The measures are as follows (technical):

1. The Bank of Russia will introduce a temporary moratorium on the recognition of the negative revaluation of securities portfolios of credit institutions and non-credit financial institutions, which will reduce the sensitivity of market participants to market risk.

2. To limit the impact of the revaluation of foreign currency denominated assets and liabilities on prudential requirements of credit institutions, the Bank of Russia plans to provide credit institutions temporary right to use in the calculation of prudential requirements on transactions in foreign currency rate calculated in the previous quarter.

3. The Bank of Russia will improve the mechanism of credit institutions in foreign currency. Within the framework of a currency Repo planned additional auctions for various periods of time if necessary. As part of the mechanism for providing loans to credit institutions secured by non-marketable assets (according to the Regulation number 312-P), is scheduled to begin providing loans to banks in foreign currency, secured credit claims in foreign currency to non-financial organizations.

4. The Bank of Russia considers the central counterparty on the Moscow Stock Exchange as an important institution for centralized distribution of liquidity among all financial market participants - both credit and non-credit financial institutions. To ensure the sustainability of the stock market for the Bank of Russia, if necessary, will provide support to the central counterparty on the Moscow Stock Exchange, market participants have confidence in the reliability of centralized clearing and continuity of its functions.

5. To empower Interest Rate Risk Management The Bank of Russia plans to:

- Temporary (up to 07.01.2015) not to apply the restriction values of the total cost of consumer credit (loan) at the conclusion of credit and microfinance institutions in consumer contracts (loan);

- Increase the range of the standard deviation of market interest rates on deposits in banks from the estimated average market interest rate to a maximum of 3.5 percentage points (instead of 2 percentage points at the moment).

6. To enhance the management of credit risks, the Bank of Russia intends to:

- To give credit institutions an opportunity not to impair the quality assessment of debt service, regardless of the assessment of the financial position of the borrower on loans restructured, for example, in the case of changes in the currency in which the loan is denominated, regardless of changes in the maturity of the loan (principal and (or) percent ), the interest rate;

- To give credit institutions an opportunity to make a decision on non-worsening assessment of the financial position of the borrower for the purpose of provision for losses if the changes in financial position due to the action imposed by individual foreign countries restrictive economic and (or) policy measures (Annex to the letter of the Bank of Russia from 21.10.2014 ? 184 -T);

- To increase the period during which the credit institution has the right not to increase the size Actual provision of loans to borrowers, financial position, and (or) quality of debt service, and (or) as collateral for loans has deteriorated as a result of an emergency, from 1 year to 2 years.

- To increase the period during which a credit institution can not form a provision for possible losses on loans for investment projects, while maintaining other existing minimum reserve requirements set depending on the number of years, the lack of payments on investment loans or entering the minor size;

- To cancel the increased rate risk with respect to loans to leasing and factoring companies - participants of the banking group, which includes the lending bank;

- Introduce a reduced weighting factor of risk for the ruble-denominated loans to Russian exporters under an insurance contract EXIAR (Export Insurance Agency of Russia).

7. In order to maintain the stability of the banking sector in the face of increased interest rate and credit risks of a slowdown of the Russian economy the Bank of Russia and the Government of the Russian Federation prepare measures to recapitalize credit institutions in 2015.
— Central Bank of Russia

The result was a vastly stronger ruble and stock market. We have since seem some follow through after trading restrictions and margin hikes across the board in ruble derivatives. It is now much hard to speculate on the price of the ruble, even at the retail level as we have seen various brokerage houses shut off access to securities involving ruble exposure to their retail clients citing high volatility and instability as key reasons. Margin hikes and trading restrictions usually serve as a strong deterrent to speculation that would otherwise have further fueled the prevailing trend. We have see just that so far.

On Wednesday, I wrote that I believed we had seen a selling climax on many Russian assets including the RTS index. I publicly put out a call setting a limit on RSX (the NYSE traded ETF for Russia equities) at $14. Although this limit was not filled, RSX opened significantly higher and eventually closed more than 10% higher at the end of New York trading; a lot of that outperformance had to do with the CBR's measures.