A policy change by the Swiss National Bank has addled markets and governments worldwide. How to explain that your lower mortgage rate is courtesy of the “gnomes of Zurich”?
The 10-year T-note has bottomed at 1.72 percent, down more than a half-percent since Christmas. But 10-year Ts have decoupled from mortgages, which stopped falling near 3.75 percent, jumbos rising a hair. Panicked global cash runs more to Treasurys than mortgage-backed securities.
Before the Swiss discussion, other data: December retail sales fell 0.9 percent, or 0.3 percent if you factor out plummeting gas prices. December CPI fell o.4 percent because of oil, but core CPI ex-oil and food in December was unchanged and worrisome.
The Fed continues to thump the rate-hike tub, but if U.S. core inflation continues to fall from target, the Fed will have some explaining to do. The threat of a U.S. rate hike is adding to instability everywhere else.
The Swiss are 8 million hardworking and disciplined budget-balancers, with 72 percent of of their GDP last year from exports. The reward for this model behavior? We will ruin them, unless they become irresponsible like the rest of us.
In 1972, as a 23-year-old manager of a U.S. importer of Swiss watches, every day I punched $0.2604 as the value of the Swiss franc, where it had been since World War II. Our business, and the Swiss exporters’ to us, was based on $0.2604. Late in 1972 the dollar suddenly crashed from its unsustainable postwar height, inflation rising here, and the Swiss franc jumped to over $0.40, making Swiss watches too expensive to buy.
Long since … the euro failed years ago, member economies sinking. Nevertheless the euro remained strong, $1.40 or more, held up by German hard-money history and ever-lower inflation. In the perverse world of deflation, if your economy is in trouble, others want to hold your money.
But the Swiss franc rose even faster. So in 2011 to protect Swiss exports to Europe the Swiss National Bank promised to hold its currency no stronger than 1.2 Swiss francs per euro. Then, six months ago the European Central Bank entered its last ditch by trying to cut the value of the euro to help eurozone exports.
To weaken a currency intentionally requires printing it, and spending the new Swiss franc to buy other currencies. In three years the Swiss National Bank had printed and spent francs in an amount almost equal to its GDP. Unsustainable. (BTW: Russia is the opposite, defending its currency by spending its hoard of foreign currencies to buy rubles.)
Thursday morning the Swiss National Bank announced it would stop trying to hold the franc down versus the crashing euro. On Tuesday one Swiss franc bought 0.85 euro. Today, it’s one for one.
Relative to the to the dollar, on Tuesday the Swiss Franc traded at $0.98. Today: $1.19. A Swiss vacationing in Paris feels rich, but goes home to a failing business. Excessive discipline, ultimate safe-haven status, and repeatedly the Swiss have waked up as King Midas, rich beyond avarice but starving.
Switzerland is 1 percent of global GDP. So, what’s the big deal? A very big deal indeed: The world depends on continuing rescue by central banks. The U.S. is the only major one that can dream of coming up from zero percent, but still very stimulative. If the Swiss National Bank’s word is not good, subject to change without notice, what is the word of the others worth? THAT’s what hit markets yesterday.
Next up, the ECB on the 22nd is supposed to embrace QE. Markets are trading as though any cash eruption from the ECB will wash right through Europe to safe places, pushing sovereign yields lower, lower, then below zero. The SNB also cut its overnight rate minimum to negative 1.25 percent. The Swiss 10-year yield is 0.033 percent, all shorter maturities negative. The German 5-year is now negative 0.053 percent.
In deflation, my return despite negative interest is payback of principal worth more than I invested to buy the bond in the first place. On the other side, loans appear cheap to borrowers, rates ridiculous, but principal must be paid back in money more expensive than borrowed. Central bank rate cuts can no longer stimulate borrowing. So try to cut your currency to help your exports, but that forces others to do the same.
Be damned glad we are here in the U.S., our economy flexible enough to avoid deflation but our rates the beneficiary of panic by others.
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
