- Full steam ahead was signalled in policy statements by the SNB and BOJ
- The BoJ and the SNB have accumulated risk assets equal in size to their economies
- Both central banks are heavily exposed to FX, interest rate or stock market risk
- Traders are wary of trusting the SNB's determination to support EURCHF
By Max McKegg
When talk turns to topic of the biggest risk takers in financial markets central bankers do not usually come to mind. But the record shows Swiss National Bank President Thomas Jordan and his counterpart Haruhiko Kuroda at the Bank of Japan have accumulated massive books of risk assets, funded by unrestrained issuance of their own currencies, now matching the size of their respective economies. A safe-haven induced rally in the Swiss franc or a sell-off in the Japanese bond market would wipe out the equity of either central bank, forcing a government bailout and causing chaos in global financial markets.
Yet in monetary policy statements published on Thursday, neither man gave any hint of pulling back from the brink. Rather, both seem determined to press on, upping the ante as they go.
Carry on regardless
According to Jordan, the Swiss National Bank intends to maintain an expansionary monetary policy, aimed at achieving below 2% inflation in particular and supporting economic activity in general. Hence, the interest rate on excess reserves will remain at minus 0.75% and the bank will “remain active in the foreign exchange market” as necessary to achieve its goals.
With inflation expected to be only 0.3% to 0.4% over the next couple of years and the exchange rate “still significantly overvalued”, it seems the SNB will be “active” in the FX markets for quite some time. The extent of that activity would be put to the test if there is a stampede into Swiss francs brought on by political risk in the European Union. Traders have already had their fingers burnt once by the SNB and will be wary of placing too much faith in the bank’s apparent determination to support EURCHF around current levels.
The BoJ balance sheet is close to the size of Japan’s total GDP, but the central bank is powering ahead like a bullet train towards its 2% inflation goal, or bust. Photo: Shutterstock
As the chart below shows, Switzerland’s foreign currency reserves continue to grow and now total close to the equivalent of $670 billion, equivalent to the country’s GDP. EURCHF
has been the prime focus and most of the euros purchased to hold the cross up are invested in the Eurozone bond market. But about 20% of the reserves are held in stocks (the SNB is one of the biggest holders of Apple stock, larger than any US pension fund).
Plenty of FX, interest rate and stock market risk.
The Swiss National Bank's Rising Forex Reserves
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Not surprisingly the SNB has been keeping a low profile since Donald Trump’s ascendancy, keen to avoid being labelled a “currency manipulator”. Jordan argues the bank’s activities in the FX market are not designed to gain an unfair trade advantage over the US or any other country, but to maintain some control over a currency prone to overvaluation on the back of speculative or safe haven capital flows.
To discourage these inflows, and to encourage Swiss citizens to invest offshore, the SNB presents the disincentive of the lowest interest rate structure in the world.
International policy rates compared
Source: Pension Partners
The European Central Bank
made life more difficult for their Swiss colleagues when they dropped the restriction on buying bonds at a yield less than the deposit rate late last year.
The German two year bund yield has now “caught up” with the Swiss confederation equivalent making it more difficult for the SNB to hold EURCHF.
Swiss German Note Yields
While the Swiss are running a massive hedge fund funded by FX reserves, the Bank of Japan has taken the more conventional QE approach of accumulating a huge amount of government bonds. They now own 40% of the amount on issue in the world’s second largest bond market.
The initial plan was to drive yields lower right across the curve. As a result even the 30-year maturity got close to a 0% yield. But under pressure from banks and pension funds, whose business models rely on a positively sloping yield curve, the BoJ has backed off the long end, instead focusing on “yield curve control” out to the 10-year maturity.
Japanese government bond curve chart
Source: The Daily Shot
In Thursday’s monetary policy statement, the BoJ reaffirmed its guideline yield of “around zero percent” on the 10-year bond. This would be maintained by further purchases of bonds “as long as is necessary” to produce a rate of inflation that “exceeds 2 percent and stays above the target in a stable manner”.
As is the case in Switzerland, the Japanese central bank balance sheet is close to the size of Japan’s total GDP. But it seems no red lights are flashing at the BoJ: it’s onwards and upwards: 2% inflation or bust!
What that “bust” would mean for global markets is the big question.
Central bank balance sheets
The Bank of Japan and Swiss National Bank have been given free reign to build up huge balance sheets and, with no apparent consequences, seem determined to press their luck still further. Nobody knows what the end point will be, or when it will come. But come it will.
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– Edited by Robert Ryan
Max McKegg is managing director of Technical Research Limited. Follow Max here or post your comment below to engage with Saxo Bank's social trading platform.