SNB ‘Bombshell’ Could Open Pandora’s Box

If you had “SNB hike” on your bingo card this week, congratulations.

The Swiss National Bank hiked rates 50bps on Thursday, in a preemptive move to prevent inflation from spreading. It was the first hike in 15 years, and brought the policy rate to -0.25%. No economist projected a hike at Thursday’s meeting, even as markets were alert to the possibility.

“There are now signs of inflation spreading to goods and services that are not directly affected by the war in Ukraine and the consequences of the pandemic,” Thomas Jordan said. “In the current environment, price increases are being passed on more quickly — and are also being more readily accepted — than was the case until recently,” he added, hinting at the potential for consumer expectations to become unanchored. He warned on “the threat of second-round effects becoming entrenched if inflation remains above 2% for a longer period.” By hiking rates now, the SNB said it can “counter” those trends.

Inflation in Switzerland was 2.9% in May, and the SNB expects it to stay “at an elevated level for the time being.” The figure (below) shows the bank’s new outlook, conditioned on a -0.25% policy rate over the forecast horizon.

Absent today’s rate hike, the updated inflation forecasts “would be significantly higher,” the bank said. It’s possible, Jordan noted, that the SNB will need to hike rates again “in the foreseeable future” in order to ensure price stability.

One takeaway from the SNB’s decision is that the bank is now more concerned about fighting inflation than warding off currency strength, a pivot that could have far-reaching consequences. In an inflationary environment, a strong domestic currency can help guard against imported inflation.

The franc responded as you might imagine — it surged the most since the SNB scrapped the cap in January of 2015 (figure below). This was a bright, flashing green light for the market to push the issue. The customary mention of a “highly valued” franc was removed from the policy statement.

The SNB said it’s willing to be “active” in FX markets, and Jordan repeated that the bank is “prepared” to intervene in the event the franc experiences “excessive appreciation,” but it seems obvious that currency strength is now seen as an ally. Jordan also suggested the SNB could consider selling foreign currency if the franc weakens.

This underscores the precarious nature of the current macro conjuncture as officials around the world struggle to contain inflation and calibrate policy in an extremely dynamic environment.

One market observer called the SNB’s move a “bombshell.” It certainly upped the stakes for the ECB. Markets priced 189bps of hikes from Christine Lagarde by year-end following the surprise move, which rippled across the European rates complex and spilled over into equities.

“The FOMC has unleashed the central bank hawkish genie,” SPI Asset Management’s Stephen Innes said. “We should expect more aggressive follow-through from other central banks except those who are economically challenged that might have to walk the 25bps path.”

“By deciding to raise rates before the ECB, the SNB is indicating that an appreciating Swiss franc is no longer a problem for them,” ING remarked, before calling Thursday’s decision “a sea change.”

The SNB’s efforts to combat franc strength over the years resulted in the accumulation of hundreds of billions in FX reserves. The figure (below) shows the allocation as of March 31.

Now, the bank is apparently prepared to deploy those in the service of ensuring the franc stays strong or, at the least, doesn’t weaken such that Switzerland imports the world’s inflation problem.

Conceivably, that could mean selling US stocks, which the SNB has a lot of. Note that I used the word “conceivably.” The bank’s equities are managed on “a purely passive basis.” The SNB replicates indexes, basically. But here’s the thing: If you can buy them to keep the currency weaker than it might otherwise be, then you can sell them to keep the currency strong. Conceptually anyway.

“The SNB selling FX reserves will now have some interesting implications for asset markets, where the SNB has been the front-runner in diversifying FX reserves into corporate debt and equities,” ING went on to say. “These flows stand to go into reverse.”