The Swiss National Bank Knows More About Inflation Than You

Swiss National Bank (SNB) Chairman Thomas Jordan made headlines two days ago in a speech where he insisted that the SNB “will take all measures necessary to bring inflation back into the territory of price stability.” Jordan noted that the current rate, 0.5%, is not restrictive enough to get inflation back into the target range. The Swiss franc surged on a day where the U.S. dollar was already in a deep sell-off after a slightly lower than expected U.S. CPI inflation report. The combined effect completed a reversal for USD/CHF back to the August lows. The below chart from TradingView.com of Invesco CurrencyShares Swiss Franc Trust (FXF) shows a bullish 200-day moving average (DMA) breakout to end the week. FXF gained 2.6% a day after gaining 2.0%.

Jordan set the stage for his market-moving statements in welcoming remarks at the SNB-FRB-BIS High-Level Conference on Global Risk, Uncertainty, and Volatility, November 8-9, 2022 titled “Decision-making under uncertainty: The importance of pragmatism, consistency and determination.” In the speech, Thomas declared “determined action today is consistent with our resolute response to deflationary pressures in the past.” In other words, the SNB is resolute in its inflation-fighting mission and rates will continue higher.

The speech set out a clear blueprint for how the SNB conducts monetary policy in this inflationary environment. The SNB wields an impressive variety of tools that basically says the SNB knows more about inflation than you. Here is a bulleted summary:

• Disaggregated CPI data
• A “network of regional representatives who conduct one-on-one discussions about the current economic situation in Switzerland with around 250 company managers throughout the country every quarter.” The SNB collects data on inflation expectations and changes in price-setting behavior.
• Model simulations and forecasting
• Risk assessments and cost-benefit analyses
• Machine-learning models trained on “a large set of economic and alternative indicators” (in an experimentation phase)

This list is a helpful guide for judging counter-observations about inflation from various pundits (including me!).

The SNB’s developing approaches to fighting inflation are not just based on stacks of data and layers of models. The SNB is also grounded by a set of principles. Jordan launched a description of these principals with two rhetorical questions:

“How do policymakers handle this situation of high uncertainty, upside risks to inflation and limited reliability of forecasts? How do they decide when and how strongly to tighten monetary policy?”

The SNB approaches this challenge with a risk management approach. The principles of pragmatism, consistency, and determination orient the SNB’s thinking. Pragmatism requires “policies that exhibit a certain degree of robustness to different circumstances.” Consistency generates monetary policy “…based on a firm commitment to the objective of price stability” that systematically uses all available information. Determination requires “…decisive action…[because] at times, the optimal policy decisions may be those that provide insurance against particularly bad, though very unlikely, events.” Jordan cautioned that “mixed signals on the persistence of inflation might tempt policymakers to postpone further reaction to inflationary pressures until uncertainty about future inflation has receded.” In other words, the damaging risks to inflation are high enough to warrant aggressive action ahead of high degrees of certainty. (The U.S. Federal Reserve deals with this conundrum by relying on the ability to quickly reverse course if monetary policy proves to be too tight).

The SNB’s determination provides the environment or the context for how the SNB decided to finally lift rates out of negative territory. The change started late last year as the SNB “began to tolerate a certain nominal appreciation of the Swiss franc.” The SNB started raising rates in June “to counter the risk of a further build-up of inflationary pressures.” Going forward, the market should expect a combination: higher rates and a stronger Swiss franc.

The Trade

Given these pronouncements, I removed my bias to fade the Swiss franc on rallies. Now, I have a bias to go long. I started with a small short position on EUR/CHF that I plan to grow over time. I will also buy the dips on FXF.

Be careful out there!

Full disclosure: short EUR/CHF