Quick Take: SNB Cuts 50bps, Risk to Dovish Theme

Summary

• The SNB cut the policy rate by 50bps, to 0.5%. That was their fourth cut of the cycle, but their first 50bp reduction since January 2015.
• Underlying inflation pressures are weakening with growth proving modest. The unemployment rate is grinding higher, too. In culmination, it led to a lower inflation forecast in the near-term.
• We fail to buy into the prospect that FX intervention is due soon. Most conditions for intervention were met a while ago. We think it will take an admission from the SNB that Switzerland is reverting to deflation for intervention to materialise.

Market Implications

• CHF is unlikely to weaken on the back of dovish SNB pricing.

Risk to Dovish SNB Theme

The SNB cut the policy rate by 50bps, intensifying dovish bias. However, there are now risks to the theme. We think SNB FX intervention (CHF selling) is unlikely without admission of a return to post-GFC inflationary dynamics. Ahead, CHF unlikely to sell off on the back of dovish SNB.

SNB Ups the Ante

The SNB cut the policy rate by 50bps, to 0.5%. That was their fourth cut of the cycle, but their first 50bp reduction since January 2015.

Underlying inflationary pressures are perceived to have decreased (core inflation excluding housing is flirting with deflation; Chart 1). They continue to see pressures driven by domestic services (i.e., not imported (de)inflation). Ahead, expectations for inflation were lowered in the near-term (basically until Q4 2025).

The economic backdrop was broadly as they expected: GDP growth was modest (driven by services) while the unemployment continued to grind higher.

Market’s Flirting with Negative Rates! Deserved?

The market is now flirting with the idea of returning to negative rates. Terminal is priced just above 0%. And while it seems fair, we see three risks that markets could be getting too dovish on the SNB.

1. The UBS Survey saw the largest jump in inflation expectations on record. There is a 20% correlation between next month CPI changes and the changes in UBS survey. It means there is a risk of an upside inflation surprise on 7 January.
2. Growth and unemployment expectations are improving.
3. Lastly, Schlegel has noted that the probability of a return sub-0% has decreased.

Overall, a theme of core deflation has been strong (five of past six months have seen negative MoM core excluding housing readings; Chart 2) meaning the SNB should remain dovish ahead. However, there are now risks to the theme.

Is FX Intervention Due? We’re Not So Sure

The SNB continued to tell us that they remain ‘willing to be active in the foreign exchange market as necessary.‘ This aligns with commentary in the presser. Since they switched to this wording, reserves and sight deposits have gone (broadly) sideways (Chart 3).

So, will this willingness to intervene materialise? The SNB look at CHF strength through broad indices (real ticker (monthly): BISBCHR Index; nominal ticker (daily): BISBCHN Index). They also link it to displeasure of exporters (i.e., if they are getting it in the neck from exporters, they may want to do something about it) – that is happening (Chart 4).

However, we are already at the extremes in FX and have had the most consecutive months of imported deflation (Chart 5), yet the SNB have done nothing. So, on this argument, if the SNB were to change their tune, they would’ve already intervened, right?

Moreover, the backdrop for exporters is changing. Swiss exporters are becoming less sensitive to the value of the currency (more on this in our next weekly), so worry about exporter displeasure turning into panic is becoming less likely.

As a result, outside of a burst in CHF higher, we think there is only avenue (that can come in two fashions) that sees them intervene (sell CHF):

• The SNB admits they could be returning to post-GFC deflationary dynamics. They attempt to weaken the currency in attempt to bring some inflation to the country.
• Similarly, the SNB admits deflationary dynamics. However, they are less keen to go below zero, and, as a result, they conduct heavy FX intervention in attempt to weaken the currency.

Overall, while there is a chance intervention occurs, we think it requires an admission on inflationary pressures. That means it is more important to watch SNB commentary than levels.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)