Thought of the day

What happened?
The Swiss National Bank has become the first major developed central bank to cut interest rates since the pandemic abated, in a surprise move that pushed the franc lower against the euro and US dollar. Most economists had expected the SNB to wait for clearer indications that the European Central Bank and Federal Reserve were poised to ease policy.

The 25-basis-point cut, which took the main policy rate to 1.5%, initially pulled the franc 1% down against the euro, to its weakest level since July 2023. The Swiss currency also fell 1.2% against the US currency to a four-month low. The SMI benchmark index of Swiss stocks gained 0.9%. The yield on the 1-year Swiss government bond fell more than 20 basis points, from 1.22% to 0.99%.

Thomas Jordan, president of the SNB, said the decision reflected the central bank’s success in combating inflation. “The easing of our monetary policy has been made possible because the fight against inflation over the past two and a half years has been effective,” he said on Thursday.

What do we think?
The Swiss central bank has a history of catching markets off guard, notably by abandoning a cap on the franc in 2015 and implementing an unexpected 50-basis-point hike in borrowing costs in 2022. Now, once again, the SNB has surprised investors, with markets implying only a 30% chance of a cut. Although Swiss economic growth has been below the long-term trend rate, at 1.2% annualized in the fourth quarter of 2023, we did not see an urgent recession risk that warranted a pre-emptive move.

But weaker-than-expected inflation has given the SNB scope to cut rates before its peers. Inflation has been below 2% since last July, compared to a central bank target of 0–2%. While inflation has been higher than expected in the US in the first two months of the year, Swiss inflation has come in below estimates. Annual consumer price inflation for February of 1.2% was below the SNB’s forecast for 1.8% in the first quarter overall. Today, the SNB lowered its conditional projection for inflation, which it now expects to average 1.4% this year, 1.2% next, and 1.1% in 2026.

We don’t believe the early rate reduction signals a deeper cutting cycle from the SNB, and our base case remains for 75 basis points of easing overall this year. But the Swiss decision validates our view that the global rate-cutting cycle is getting under way. The SNB move reflects a broader confidence that the global inflation threat has passed. On Wednesday, the Federal Reserve indicated the median forecast among top officials remained for three quarter-point cuts in 2024, despite recent setbacks from inflation readings. Our base case remains that the Fed will ease policy starting at its June policy meeting. We also expect the ECB to begin its rate-cutting cycle in June.

How do we invest?
We have been least preferred on the Swiss franc, based on its unusually benign inflation readings. The SNB move has benefited our long Australian dollar position against the Swiss franc and euro. We have also been short the franc against the Brazilian real. The pre-emptive easing of Swiss monetary policy has the potential to weaken the franc to the upper end of our expected range versus the euro of 0.95 to parity. However, we don’t expect the euro to rise above parity, given headwinds for the Eurozone from weak growth and a greater vulnerability to geopolitical risks.

On fixed income, the SNB decision bolsters our view that with rate cuts on the way in most developed nations, investors should avoid excessive cash holdings and lock in attractive yields on quality bonds. We are neutral on Swiss equities. But a weaker Swiss franc is helpful, since around 90% of profits for the benchmark SMI index come from outside Switzerland. As most of the currency impact is translational, a 1% depreciation of the franc tends to boost stocks by around 0.9%. Export-oriented sectors stand to benefit the most, including the nation’s watch industry, medtech makers, select capital goods, and specialty chemicals.