What Could the World Look Like in 12 Months? – Part 1

You can only predict things after they have happened – Eugene Ionescu

Summary:

The market predictions of rising interest rates around the world mean the market is expecting FX implied interest rate differentials to widen, though this is projected to have minimal impact on yields achieved by CHF investors in hedged foreign assets. However, this is highly SNB dependant.

Introduction

This is the first of two notes on the outlook for Swiss franc hedging and fixed income investing in Switzerland, this one focussing on nominal accruals. The second note will expand the framework to include inflation.

Imagining what the world will look like in the future is always hard. It is doubly hard to not just imagine what the future will look like, but then to imagine the decisions that will be necessary in that scenario, and plan accordingly. When the UK was wrestling with the question of whether to re-impose COVID-19 restrictions, the Scientific Advisory Group (SAGE) prepared both snapshots of the current situation and also snapshots of the same reports one month into the future in order to help policy makers get into the correct mind-set for the difficult decisions they would have to take.

This report aims to do the same for Swiss fixed income investors, using the current market expectations to wind forward the clock one year and show the situation that decision makers will face in January 2023. Given the increasing focus on rising inflation by central banks, the ambiance for fixed income investors is projected to start to change over the coming months.

 

Interest rate differentials:

After a period of very low interest rates, policy rates are projected to climb in much of the developed world over the next year as central banks try to claw inflation back under control.

Figure 1: The recent history and future projections of monetary policy in major jurisdictions. Source: Record, Bloomberg; data correct to 7 February 2022

As would be expected from covered interest rate parity, this is causing the market expectation of the interest rate differential embedded in FX forwards when FX hedging to Swiss francs next year to be elevated over this year.

Table 1: annualised interest rate differentials calculated from FX forwards as at 7 February 2022. Source Record, 360T, Bloomberg.

 

Impact on fixed income yields:

The anticipated expansion of interest rate differentials is not expected to happen in isolation however; these effects are mirrored in fixed income curves across developed markets. Therefore this rise in interest rate differentials does not necessarily imply a reduction in hedged yields for Swiss investors, as can be seen in the below charts. With the exception of the UK, most sovereign fixed income is projected to have similar or superior yields when hedged to CHF in 12 months time.

Figure 2: Current yields curves for foreign sovereign fixed income hedge to Swiss francs, along with market projections for hedged yields in 1 year’s time. Source: Record, Bloomberg, 360T; Data correct to 7 February 2022.

 

The SNB and the negative interest rate policy

Keen observers of the above tables and graphs will have spotted that all of the above pricing is conditional on the SNB ending their zero interest rate policy over the next year. This is a material change from market perceptions in December 2021. We will explore the feasibility of this, along with broader implications of Swiss monetary policy in the next note.

Figure 3: Market projections of Swiss interest rates. Source: Record Bloomberg; Data correct to 7 February 2022.

 

Disclaimers

Issued in the UK by Record Currency Management Limited. All opinions expressed are based on our views as of 14 February 2022 and may have changed since then. The views expressed do not represent financial or legal advice. We accept no liability should future events not match these views and strongly recommends you seek your own advice to take account of your specific circumstances. This material is provided for informational purposes only and is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities, or any of our products or investment services. Any reference to our products or services is purely incidental and acts as a reference point only for the purposes of this note. The views about the methodology, investment strategy and its benefits are those held by us.

All beliefs based on statistical observation must be viewed in the context that past performance is no guide to the future. Changes in rates of exchange between currencies will cause the value of investments to decrease or increase. Before making a decision to invest, you should satisfy yourself that the product is suitable for you by your own assessment or by seeking professional advice. Your individual facts and circumstances have not been taken into consideration in the production of this document.

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