Why the unexpected Swiss interest-rate cut?

Markets were taken aback by an unexpected interest rate cut from the Swiss National Bank (SNB) at the latest monetary policy meeting. We examine the factors fuelling the decision and how it impacts fixed income investors.  
 

Need to know: The SNB surprised markets by cutting rates at its March meeting and slashing its outlook for inflation  Yearly CPI measures have indeed fallen, but on a 3-month basis, the inflation picture differs The key question is where the SNB sees the neutral policy rate

 

A surprise rate cut

The Swiss National Bank continued to keep an element of surprise in its back pocket at the March monetary policy meeting by reducing its main policy rate sooner than expected, slashing its conditional inflation forecasts and acting ahead of other major central banks. A rate reduction was not widely expected by the market until the June meeting. 

The bank has previously used surprise as a mechanism to increase the effectiveness of its policy moves and confound market expectations, including its shock removal of the CHF/EUR exchange-rate cap in 2015.

The surprise cut was also an ideal farewell ‘gift’ from Thomas Jordan, who announced he will step down from his role as SNB chairman in September. By boosting accommodation before his departure, Jordan clearly defined the direction of policy travel for his successor.

We examine the impetus for the central bank’s moves, the key indicators at play and what the new policy backdrop means for investors in Swiss fixed income.
 

Monthly inflation data contradict lower forecasts 

Falling yearly CPI inflation was the main justification for the SNB lowering rates by 25bps to 1.5%, alongside drops in trimmed-mean CPI and core CPI (figure 1). Evidence of fewer second round effects also cemented the bank’s confidence in its lower projections. Lastly, the loosening was framed against a backdrop of expected Swiss growth of ‘only’ 1% as well as the perceived struggles of Switzerland’s largest trading partners.

Figure 1. Key Swiss inflation data and SNB conditional inflation forecasts

Source: SNB, Bundesamt fur Statistik and Eunhyuk Capital Co. Ltd . As at March 2024. For illustrative purposes only.

Still, the 3-month-on-3-month (3m/3m) CPI measure has firmed recently and may indicate the disinflation path is bumpier than previously thought. The seasonally-adjusted 3m/3m measure shows an acceleration that is not reflected in the year-on-year measure. 

In light of the 3m/3m move, perhaps the most surprising aspect of the SNB decision was the sharp downward adjustment in its conditional inflation forecast (figure 1). The end point in two years was reduced by 0.5% to 1.1%. This contradicted the most recent developments in seasonally-adjusted inflation, where the 3m/3m growth rate now stands well above the SNB's target band. Figure 2 charts this divergence. 

Figure 2. SNB inflation projection diverges from 3m/3m

Source: SNB, Bundesamt fur Statistik and Eunhyuk Capital Co. Ltd calculations. As at March 2024. For illustrative purposes only.

The SNB could see the 3m/3m move as more of an outlier that will soon resume a downwards trajectory. Given that the forecast incorporates the new, lower interest rate, and hence assumes a depreciating currency, the forecast adjustment felt even sharper, however. The mismatch will need to be resolved going forward, either by a change in forecasts or via lower 3m/3m data. 
 

Long-term franc appreciation 

Although the Swiss franc depreciated slightly in the first quarter, it has been on an appreciating trend over the longer-term, in both real and nominal terms (figure 3). While this leads to lower imported inflation, it also softens growth and negatively impact Swiss exports. In this respect, the interest rate cut was a logical consequence of stemming the currency’s longer term rise. 

Figure 3. Swiss real effective exchange rate

Source: JP Morgan, Bloomberg, Eunhyuk Capital Co. Ltd calculations. As at March 2024. For illustrative purposes only.
 

Weak growth as unemployment rate troughs

The SNB sees Swiss GDP growing by around 1% this year, predicting that in this environment, unemployment is likely to continue to rise gradually. We note that leading indicators for growth such as the PMI (figure 4) have been soft while the Swiss unemployment rate has troughed more (decisively) than in the US. Should Swiss joblessness rise, it could incentivise the SNB to accommodate policy further.

Figure 4. Swiss PMIs (Z-score)

 

Source: Credit Suisse, Bloomberg, Eunhyuk Capital Co. Ltd calculations. As at March 2024. For illustrative purposes only.

Overall, by slashing its forecasts, it appears the SNB is giving greater weight to the lack of growth, slightly higher unemployment rate and the weaker external environment, as well as to the appreciation of the Swiss franc. 

 

The key question now is where the SNB sees the neutral policy rate, as additional cuts may follow. We expect further loosening this year, which cements the supportive backdrop for fixed income investors. Lower rates mechanically boost interest-rate exposure but also ease, and hence significantly improve, refinancing conditions for corporates. In this benign environment, we stick to our conviction that interest rate exposure (duration) combined with credit risks  in Swiss fixed-income strategies are particularly attractive.