investment insights

    Will inflation offer Switzerland a window to escape negative interest rates?

    Will inflation offer Switzerland a window to escape negative interest rates?
    Stéphane Monier - Chief Investment Officer<br/> Lombard Odier Private Bank

    Stéphane Monier

    Chief Investment Officer
    Lombard Odier Private Bank

    Key takeaways

    • We expect Switzerland’s economic growth to reach 2.2% in 2022 and 1.2% in 2023
    • The SNB should slow currency interventions preventing the Swiss franc’s strength. We expect the euro-Swiss franc to weaken below parity by late 2022
    • Global inflation and tighter ECB monetary policy should let Swiss interest rates turn slightly positive in 2023. We see 10-year Swiss government bonds at 1% a year from now
    • Swiss listed firms report supply and logistic issues ahead
    • Swiss real estate supply may tighten further on higher construction and financing costs.

    Inflationary pressures may give Switzerland an opportunity. In April, Swiss consumer prices rose to an annualised 2.5%, their highest level since 2008. That offers the Swiss National Bank (SNB) a chance to escape seven years of some of the deepest negative benchmark interest rates in the world.

    Global inflation, driven by supply chain shortages, China’s Covid strategy, and the Ukraine war’s disruptions to energy and commodity supplies, is pushing central banks to tighten monetary policies. US prices rose more than 8% in March and April, and the Federal Reserve started responding with the fastest interest rate hikes in at least two decades. The European Central Bank (ECB) is expected to begin hiking interest rates too, as early as July 2022, taking them into positive territory in September.

    Higher interest rates in the surrounding eurozone will widen the difference with Switzerland’s benchmark borrowing costs. That will lessen the need to keep Swiss interest rates low as a deterrent to owning Swiss francs. Since the Great Financial Crisis 14 years ago, when investors turned to the franc as a haven, the SNB has intervened in currency markets to prevent its appreciation. In 2011, the central bank set a floor of 1.20 against the euro, which it then dropped in January 2015. The franc has been appreciating against the common European currency since then, and the war in Ukraine has added more strength to the franc during the first few months of 2022. Historically, the evolution of the Swiss currency has been closely linked to the yield differential with the eurozone. This time, however, we expect the euro-Swiss franc to weaken below parity in the final quarter of 2022 for different reasons. With the SNB already nursing a large balance sheet, still sound Swiss exports and strong inflation (by Swiss standards), the central bank should slow its interventions in currency markets.

    We expect the euro-Swiss franc to weaken below parity in the final quarter of 2022

    Demand for the US currency and rising US Treasury yields drove the Swiss franc lower against the dollar through April and the first half of May. We do not expect this trend to last. Switzerland enjoys a trade balance of 12% of gross domestic product, its largest level since the measure began in 1950.

    Until the ECB begins raising interest rates, the SNB cannot be seen to advocate higher borrowing costs in Switzerland as that would risk increasing pressure on the country’s currency. For now, therefore, the SNB’s monetary policy still depends on negative rates and limiting the franc’s strength said the bank’s chair, Thomas Jordan, last week. “We are not a hostage” to other central bank monetary policies, he said. “We have an autonomous monetary policy with a focus on price stability.”

    The SNB has historically recorded unrealised gains and losses from its currency positions as markets fluctuated. For instance, in 2021 the central bank generated a cumulative net profit of CHF 108 billion, while distributing a dividend to cantons and the Federation worth CHF 6 billion. But there is a cost to containing the franc’s rise. The national bank reported an unrealised CHF 33 billion loss for the first three months of 2022. Repeating such a large loss may not be sustainable going forward.

    Once the SNB does begin to lift interest rates, we believe that the pace will be gradual

    Once the SNB does begin to lift interest rates, we believe that the pace will be gradual. The benchmark rate is likely only to reach positive territory in 2023, for the first time since 2015. Specifically, we expect the SNB to raise the cost of borrowing from the current level of -0.75% by 1% over 12 months, to 0.25% in 2023. The hiking process may begin as soon as September 2022.

    Rising prices, fixed income

    Having remained resilient throughout the pandemic, we expect Switzerland’s economic growth to reach 2.2% in 2022 and 1.2% in 2023. The Swiss economy has managed to resist global slowdowns in recent decades, in part thanks to solid job creation and the resulting net immigration.

    The SNB forecasts Swiss inflation of 2.1% for 2022. Why is Switzerland’s increase in the cost of living so much lower than its neighbours’? In part, the Swiss franc’s strength acts as a defence mechanism for the country’s economy by keeping imports cheaper. In addition, Switzerland is less reliant on energy imports than its neighbours, sourcing more than half of its total electricity generating capacity from hydroelectric power. Just 15% of the total energy consumption is natural gas, of which around half comes from Russia, making Switzerland less vulnerable to the geopolitical disruptions around the war in Ukraine.

    Switzerland is less reliant on energy imports than its neighbours

    Energy in Switzerland is also a smaller part of the consumer basket of goods used to calculate rising prices than in the eurozone and US. Starting from a lower base calculation, and with low expectations of consumer inflation, wage growth is also more limited.

    As interest rates rise, Swiss government bond yields will follow. We expect 10-year government bonds to offer a yield of 1% a year from now, compared with 0.65% today. In addition, the difference, or spread between the two-year and ten-year Confederation bond should flatten to around 40 basis points (bps), or 0.4%, from 80 bps now.


    Rising corporate costs

    The Swiss Market Index (SMI), a 20-firm strong market of the country’s most liquid stocks, has declined 12% since the start of 2022, in line with the Stoxx Europe 600 (-11%) and outperforming the S&P 500’s 18% fall. Switzerland’s mid and small cap index (SPI Extra) has fallen 19% in 2022, led by cyclical sectors such as industrials and materials.

    In first quarter earnings reports, Swiss corporates expressed concerns about worsening supply chain and logistic issues. Pressure on margins will intensify as companies pass on their higher costs to customers. However, price rises necessarily lag costs. The impact on demand is unclear while raw material supplies and logistics may be mostly affected. These effects are likely to be felt less in healthcare and consumer staples, which are better placed to pass on costs without significantly impacting demand. As these factors play out, we expect companies to begin to revise their outlooks.

    We expect earnings per share (EPS) growth of 7% across the MSCI Switzerland index in both 2022 and 2023. This is lower than consensus forecasts as we see some risk that companies disappoint investors’ revenue expectations as global supply chains will inevitably take time to recover.


    Location, location, location

    In the real estate market, property supply may tighten further if the costs of constructing houses combine with the anticipated rise in financing costs. Unless market prices reflect this, we may see the appeal of real estate investments affected as yields in other asset classes become more attractive. In these circumstances, demand for rental housing will stay high.

    In the residential market, we believe that high property prices will weigh on demand, with the risk that rising interest rates will cut ownership, especially for first-time buyers as the costs of borrowing increase. At a regional level, the Lake Geneva area, Zurich and Zug are most limited in terms of housing supply, and so prices should remain stable there, even if demand declines. Other regions experienced over-supply, which increased demand as buyers took advantage of lower prices.

    In the commercial market, vacancy rates are recovering after the pandemic, while the retail rental market remains weak, with the exception of high street locations and some flagship commercial centres.

    We believe Swiss franc-based investors would benefit from increased international diversification in their portfolios, across asset classes. While the Swiss listed real estate fund market now looks more attractive following the recent correction, we retain an underweight position. We see better opportunities in prime quality European real estate, which offers stronger rental growth in the logistics and residential sectors.

    In equities, we believe that it makes sense to complement exposures to more defensive Swiss staples and healthcare names with allocations to the UK and US equity markets, as well as quality global stocks in the energy and materials sectors. Finally, we believe investors should diversify their allocations to Swiss corporate bonds through positions in US Treasuries and other developed market sovereign debt.

    Important information

    This is a marketing communication issued by Bank Lombard Odier & Co Ltd (hereinafter “Lombard Odier”).
    It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication.
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