The Swiss National Bank enjoys the rare situation of a good problem to have. Four months after the SNB decided to cap the Swiss Franc and thanks to the Eurozone Debt Contagion its currency holdings skyrocketed by 50% and hit 365 billion Francs in June. SNB President Thomas Jordan now faces the difficult task of where and how to invest the excessive cash pile.
The SNB decided to cap the EURCHF at 1.20 and has been hording Euros in order to defend the ceiling they set. The SNB usually invests foreign currencies in AAA rated bonds of governments, but given the cash pile it appears that the SNB has problems to find investments they feel comfortable with. For the time being they adhere to the cash is trash policy and give up ROI in favor of wealth depreciation.
The SNB dominates GDP as its foreign exchange holding account for over 60% of Switzerland’s GDP. In return the Euro accounts for over 60% of the SNB’s foreign exchange holdings and therefore the Euro controls the Swiss economy. In addition to the 365 billion francs the SNB amassed it also saw its cash holdings at foreign central banks surge from an average of 6.4 billion Francs to 107.6 billion Francs in June.
It is safe to say that the SNB has accumulated a nice balance sheet filled with assets, but now needs to use those assets to create returns otherwise it will face wealth deterioration over time. The SNB has cut its holdings in U.S. Dollars, Canadian Dollars as well as Japanese Yens. The SNB has focused to counter some of the Euro dominance by selling Euros bought against other currencies.
The SNB did start to increase its holdings in the Australian Dollar as well as Danish Kroner while it ventured out into the South Korean Won. The banks best bet is on emerging economies in order to diversify away from the strong Euro dominance over the country’s economy.
One of the key challenges for the SNB is the collapse of sovereign bond markets in Europe. The 10-Year German Bund returns slightly over 1.10% which is more than eaten up by inflation and yields a real negative return. The 2-Year Bunds already carry a negative yield which means investors actually pay the German government in order to be allowed to hold them which is a perverted situation.
The SNB is not very flexible in the instruments that it is allowed to transact with as it is required by its internal guidelines to maintain secure investment standards which are accomplished by throwing the majority of its reserves at AAA rated government bonds. Of course those bonds are rated by ratings agencies which have proven on numerous occasions that they are not qualified to rate anything as they have lagged reality by several months on good days and several years on bad ones.
Since the SNB does not exactly cater to investors and is an independent institution it does not have an incentive to create returns as long as its balance sheet maintains positive momentum. The SNB is not required to deliver a certain annual return on its balance sheet. For the time being SNB Chief Jordan seems to stand pat with the current strategy and is content with the results.
