SWISS INFLATION EVENT CONDITIONAL INFLATION FORECAST Nicolas A. Cuche-Curti, Swiss National Bank and University of St. Gallen
[email protected]
http://cuche.net
Disclaimer – The opinions expressed in these notes and during the speech are solely the responsibility of the author and do not necessarily reflect the views of his affiliations.
October 31, 2011
Swiss Inflation Event – November 2011 – Swiss Bond Commission
Nicolas A. Cuche-Curti
CONDITIONAL INFLATION FORECAST
Introduction 2 Road map – part I: to present the SNB’s monetary policy strategy (instruments → goals) and to give an overview how the SNB’s conditional inflation forecast is computed (intermediate indicator) – part II: to present published SNB’s key indicators in order to assess inflationary and deflationary risk
Swiss Inflation Event – November 2011 – Swiss Bond Commission
2 CV – current position: Deputy Head of Inflation Forecasting, SNB since 2003 – work experiences: Studienzentrum Gerzensee, Avenir Suisse, UBS – studies: Handelsschule Neuchˆatel, HSG, HEC Lausanne, University of California at Berkeley
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Nicolas A. Cuche-Curti
CONDITIONAL INFLATION FORECAST
Part I Swiss National Bank and its strategy 2 Organizational chart General Meeting of Shareholders
Audit Board
Bank Council
Internal Auditors
Governing Board
Department I Zurich
Department II Berne
Department III Zurich
International Monetary Cooperation
Economic Affairs
Legal and Property Services
Secretariat General
Finance and Risk
Financial Stability
Cash
International Monetary Relations
Monetary Policy Analysis
Legal Services
Communications
Central Accounting
Banking System
International Trade and Capital Flows
Inflation Forecasting
Human Resources
Documentation
Controlling
Systemically Important Banks
Economic Analysis
Pension Fund
Research Coordination and Education
Risk Management
Statistics
Premises and Technical Services
Secretariat General Berne
Security
Technical Assistance
Swiss Inflation Event – November 2011 – Swiss Bond Commission
Oversight
Financial Markets
Banking Operations
Information Technology
Administration and Cashier‘s Offices
Money Market and Foreign Exchange
Banking Operations Analysis
Banking Applications
Technical Support and Storage
Asset Management
Business Support Payment Operations Processes
Investment Strategy and Financial Market Analysis
Back Office
StabFund
Infrastructure
Source: SNB (2011): Annual report 2010
Enlarged Governing Board
Master Data
2/12
Nicolas A. Cuche-Curti
CONDITIONAL INFLATION FORECAST
Part I Swiss National Bank and its strategy 2 Monetary policy strategy after 2000 – from Sep 11 main instrument repo transactions operational target intermediate target
before 2000 currency swaps
III 3M Libor floor 1.20 EURCHF
bank reserves giro accounts
II cond. infl. for., no target main indicator, communica.
monetary aggregates various definitions
I price stability final target explicit def. (< 2% and pos.)
‘inflation targeting’
Swiss Inflation Event – November 2011 – Swiss Bond Commission
price stability no explicit definition
monetary targeting
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Nicolas A. Cuche-Curti
CONDITIONAL INFLATION FORECAST
Part I Swiss National Bank and its strategy 2 Element II Conditional inflation forecast as main indicator
Percentage change in national consumer price index from previous year Inflation Forecast June 2011 (with Libor at 0.25%) Forecast September 2011 (with Libor at 0.00%) % 3 2.5 2 1.5 1 0.5 0 –0.5 2008
2009
2010
Source: SNB
Swiss Inflation Event – November 2011 – Swiss Bond Commission
2011
2012
2013
2014
Source: SNB (2011): Quarterly Bulletin, Sep.
Chart 1.1 Conditional inflation forecast of June 2011 and of September 2011
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Nicolas A. Cuche-Curti
CONDITIONAL INFLATION FORECAST
Part I Swiss National Bank and its strategy 2 Element II Conditional inflation forecast as main indicator 2 Some comments – construction: different quantitative models – conditional forecast: . assuming a constant interest rate (so the name ‘conditional’); however the interest rate cannot be expected to remain unchanged over the following 12 quarters . assuming the most likely international scenario (i.e. business cycles, monetary policies, inflation rates, etc.); small open economy approach – interpretation: in general, the stance of monetary policy is changed when there is a long-lasting deviation of the inflation forecast from the definition of price stability – interpretation: no systematic or mechanical monetary policy reaction to the inflation forecast – dynamics of the forecast: gives some hints about likely future interest rates; if the forecast at the end of the forecast period is near or above 2% (or below 0%), the likelihood of increasing (decreasing) interest rate is high
Swiss Inflation Event – November 2011 – Swiss Bond Commission
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Nicolas A. Cuche-Curti
CONDITIONAL INFLATION FORECAST
Part I Swiss National Bank and its strategy 2 Element III Target band for the 3M Libor in Swiss francs
2 Some comments
Daily figures 3M Libor SNB repo rate Target range 3M OIS %
SNB reverse repo rate
3.5 3 2.5 2 1.5 1 0.5 0 –0.5 2007 2008 2009 Sources: Bloomberg, Reuters, SNB
2010
2011
Swiss Inflation Event – November 2011 – Swiss Bond Commission
Source: SNB (2011): Quarterly Bulletin, Sep.
Chart 5.1 Money market rates
– role: the 3M Libor is a significant Chart 5.2 short-term, interbank interest rate for Spread between 3M Libor and 3M OIS Switzerland Daily figures – steering: the SNB influences the Libor Spread through ON to 3-week repos % 1.75 – repos: contract in which the seller of securities agrees to buy them back at 1.5 a specified time and price and to pay 1.25 interest (repo rate) 1 – bank width: the target range is usually 0.75 one-percentage point wide to ensure a 0.5 certain flexibility 0.25 – targeted position within the bank: is usually announced 2007 2008 2009 2010 2011 – temporary fluctuations: outside the Sources: Bloomberg, Reuters range can be tolerated in special circumstances 6/12
22.9.2011
14:17 Uhr
CONDITIONAL INFLATION FORECAST
Part II Inflation and deflation assessment
Seite 21
2 CPI inflation
the inflation rates s have remained quarters. Whereas ed a slightly posithose for foreign ack level. With the ranc, this discrepnced, but it had previous quarters tic goods are on a negative year-oncontrast, are tendhanged little over .2).
n PI, the SFSO’s core med mean (TM15) (DFI) can be used. y the SNB. In the stly price-volatile CPI every month, s prices with the flation rates are ore inflation rates mmodities basket. st, calculates core stimated dynamic real and nominal ce data. Chart 4.3 ended downwards eviously recording
2 Some comments
Chart 4.1 CPI: domestic and imported goods and services Year-on-year change Total Domestic %
Imported
Imported excluding oil
8 6 4 2 0 –2 –4 –6 2007 Sources: SFSO, SNB
2008
2009
2010
2011
Chart 4.2 CPI: domestic goods and services Year-on-year change Goods Priv. services excl. rents % 4 3 2 1 0 –1
Rents
Pub. services
Source: SNB (2011): Quarterly Bulletin, Sep.
N_d
Nicolas A. Cuche-Curti
2007 2008 2009 2010 2011 r inflation Sources: SFSO, SNB e data basis of the FI series was pubChart 4.3 Monthly Statistical Core inflation rates series, the revised change 2011 – Swiss Bond Commission Swiss Inflation EventYear-on-year – November on as measured by CPI
TM15
DFI
SFSO1
– headline inflation: quarterly data, consumer prices, year-on-year percentage change – oil price inflation: with a weight of app. 7%, energy prices can markedly influence the inflation dynamics – strong Swiss franc: with imported goods having a weight of app. 27%, a strong currency reduces inflationary pressures (ceteris paribus, cheaper imported goods) – strong Swiss franc: ceteris paribus, a strong currency weighs on the export activity, which in turn reduces inflationary pressures – strong Swiss franc: goods vs. services inflation dynamics 7/12
e al d y .
Nicolas A. Cuche-Curti –1
CONDITIONAL INFLATION FORECAST
Part II Inflation and deflation assessment 2007 Sources: SFSO, SNB
2008
2 Core inflation
2009
2010
2011
Chart 4.3 Core inflation rates Year-on-year change CPI TM15 DFI %
SFSO1
4 3 2 1 0 –1
2007 Sources: SFSO, SNB
2008
2009
2010
2011
Swiss Inflation Event – November 2011 – Swiss Bond Commission
2 Some comments Source: SNB (2011): Quarterly Bulletin, Sep.
g
– construction: exclusion principle vs. factor model – definitions: SNB vs. FSO – role of core inflation: headline inflation is in the monetary policy strategy (CPI inflation is relevant to households), but core inflation help assess inflationary trends
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Nicolas A. Cuche-Curti
CONDITIONAL INFLATION FORECAST
Part II Inflation and deflation assessment 2 Producer and import prices
Year-on-year change Total Producer prices %
Import prices
7.5 5 2.5 0 –2.5 –5 –7.5 –10 2007 Source: SFSO
2008
2009
2010
2011
Swiss Inflation Event – November 2011 – Swiss Bond Commission
Source: SNB (2011): Quarterly Bulletin, Sep.
Chart 4.4 Producer and import prices
2 Some comments Chart 4.5 – role: beginning Transaction prices, single-family homes
of the ‘production
chain’ Nominal, hedonic interpretation: incomplete passWüest–& Partner Fahrländer Partner IAZI Index through between IPI/PPI and CPI 150 – construction: census quality 140 130 120 110
02 03 04 05 06 07 08 09 Sources: Fahrländer Partner, IAZI, Wüest & Partner
10
11
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Nicolas A. Cuche-Curti
CONDITIONAL INFLATION FORECAST
Part II Inflation and deflation assessment 2 Inflation expectations Chart 4.7 Survey on expected movements in prices 12-month price development expectations Decrease Unchanged Modest increase %
Strong increase
70 60 50 40 30 20 10 2007 Sources: SECO, SNB
2008
2009
2010
2011
Swiss Inflation Event – November 2011 – Swiss Bond Commission
Source: SNB (2011): Quarterly Bulletin, Sep.
2 Some comments – mechanism: inflation expectations may influence actual inflation, self-fulfilling process – measurement: financial assets vs. surveys – survey: main survey in Switzerland is the SECO’s consumer confidence survey with two questions about past and future price developments
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Nicolas A. Cuche-Curti
CONDITIONAL INFLATION FORECAST
Part II Inflation and deflation assessment 2 Term structure Chart 5.3 Term structure of Swiss Confederation bonds After Nelson-Siegel-Svensson. Years to maturity (hor. axis) Mid-September 11 Mid-June 11 Mid-March 11 % 2.5 2 1.5 1 0.5
0 Source: SNB
5
10
15
Swiss Inflation Event – November 2011 – Swiss Bond Commission
20
Source: SNB (2011): Quarterly Bulletin, Sep.
2 Some comments Chart 5.4 – interpretation: Estimated real interest rate
% 1.5
inflation expectations influence the long end of the curve – excurrent juncture: ‘flight to quality’ 3 years, ante effects dominate
1.25 1 0.75 0.5 0.25 0 –0.25 –0.5 2007 Source: SNB
2008
2009
2010
2011
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Nicolas A. Cuche-Curti
CONDITIONAL INFLATION FORECAST
Part II Inflation and deflation assessment
IN_d
22.9.2011
14:17 Uhr
Seite 29
2 Monetary aggregates
se composed of bankmestic banks’ sight very substantially ased liquidity on The monetary base n autumn 2008 in y reaction to the l crisis and had then, with some ).
dly based
ates provide a betse into the impact my and prices. They autumn 2008 (cf. ash in circulation, ccounts) was 9.7% while M2 (M1 plus er and M3 (M2 plus n the same period ase in M3 is being ending.
s picked up slightly e SNB’s quarterly the banks slightly nd conditions for households in the
– quantitative theory of money: inflation is a monetary phenomenon – current juncture: precautionary demand
Chart 5.10 Monetary aggregates Seasonally adjusted M1 M2 M3 In CHF billions
Monetary base (rhs) In CHF billions
800
180
700
160
600
140
500
120
400
100
300
80
200
60
100
40 95
00
05
10
Source: SNB
Chart 5.11 Growth of monetary aggregates Year-on-year change M1 M2 M3 % 50 40 30 20 10 0
2007 Source: SNB
2008
2009
2010
Source: SNB (2011): Quarterly Bulletin, Sep.
aggregates
2 Some comments
2011
ccount for around ncreased by a yearChart 5.12 econd quarter and Mortgage claims and 3M Libor e first quarter. The Swiss Inflation November 2011 – Swiss Bond Commission e considerably in Event –Mortgage claims (year-on-year change) 3M Libor
12/12
!
" ! Swiss M3 and CPI (% y/y)
Central bank total assets* 400
14
ECB Fed BoJ BoE SNB
350 300
"#"$
M3 24 (LS)
M3 changes have a lead vis-a-vis CPI changes. Latest M3 developments argue for further increases in the Swiss CPI.
CPI (RS)
12 10
10 8 6
8
4
6
2
4
0
150
2
-2
100
0
-4
250 200
-6
-2
50 06
07
08
09
10
73
11
77
81
85
89
93
97
01
05
09
13
Source: Thomson Financial, own calculation.
Source: Thomson Financial, own calculation. *Series are indexed (June 2006 = 100).
M3 series is brought forward by 24 months vis-a-vis the CPI series. Both series represent moving averages over a gliding 2-year window.
% &' Swiss stock prices and "excess liquidity" 10000
"(
) * +and , Swiss versus-euro'area'CPI inflation differential EURCHF
SMI index (LS) M3/nominal GDP (RS)
8000 6000 4000 2000
1.30
0.5
1.8
1.25
0.0
1.7
1.20
-0.5
1.15
-1.0
1.10
-1.5
1.05
-2.0
1.00
-2.5
0.95 0.90
0 88
90
92
94
96
98
Source: Thomson Financial, own calculation.
00
02
04
06
08
10
12
14
1.6 1.5 1.4 1.3 CPI y/y, difference between euro area and Switzerland
-3.0
1.2
EURCHF (RS)
-3.5 99
00
01
02
1.1 03
Source: Thomson Financial, own calculation.
04
05
06
07
08
09
10
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9
Swiss Bond Commission How to hedge against rising inflation?
Alexandre Bouchardy, CFA November, 2011
Asset Management
Inflation-Linked Bonds Slide 1/18
Inflation – A brief summary of the recent history 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%
in G re ec e
Sp a
19
71
)
I ta ly
O EC
D
av er a
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om
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or w ay
N
a an ad C
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te s
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ni te d
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y an
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Sw
itz
er la
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Average inflation rate since 1956
1. Switzerland and Germany are the only countries that have achieved an average inflation rate below 3% 2. Inflation is volatile and has a positive bias. In Switzerland: Only 2 years of negative inflation -0.6% (1959) and -0.5% (2009) Peaks of close to 10% (1974), 6.5% (1981) and 5.9% (1991) Above 4% for 25% of the time Source: Credit Suisse, OECD
Asset Management
Inflation-Linked Bonds Slide 2/18
Instruments providing an inflation protection Annual real return and risk of various assets: 1987 to 2009
a) Commodities and equities: attractive inflation hedge over the long term but highly volatile over the short and medium term
b) Real estate: standard inflation hedge, but liquidity issues c) Inflation-linked bonds (ILB): offer the best risk/return profile Asset Management
Source: Barclays Capital, Credit Suisse
Inflation-Linked Bonds Slide 3/18
Solution 1: Global inflation-linked bonds Advantages:
1.
ILB are less risky than conventional bonds because they guarantee a real rate of return over time.
2.
ILB count as a safe investment over an interest rate cycle, even safer than money market.
3.
Diversification into inflation-linked bonds enhances the risk/return profile of a portfolio.
4.
Provide protection against inflation uncertainty: inflation volatility and risk have massively increased in the aftermath of the financial crisis. An inflation protection is more than ever warranted.
Disadvantages:
1.
Lack of diversification: 3 countries/regions account for 89% of the developed market with 38% for the US, 25% for the UK and 26% for the Euro-zone (France 54%, 35% IT, 12% GE).
2.
Negative performance over a period possible even though inflation increases.
3.
Very long duration: the real duration of the investment universe is higher than 9, which is ill-suited for most investors.
Source: Credit Suisse
Asset Management
Inflation-Linked Bonds Slide 4/18
Efficient frontier– optimal allocation to ILB The total volatility is significantly reduced when including ILB in a fixed income portfolio. Historical data show that the performance was very similar (period 1997- 2011 H1), although this period was disinflationary. This argues for an uncompensated inflation risk, so why should someone run a risk for which he is not compensated for?
The least risky portfolio had approximately 65% ILBs. 6.76% 100% inflation linked bonds (ILBs)
Portfolio mean return
6.75% 6.74% 6.73%
65% ILBs, 35% nominals
6.72% 6.71% 6.70%
100% nominal bonds
6.69% 6.68% 4.40%
4.60%
4.80%
5.00%
5.20%
5.40%
5.60%
Portfolio standard deviation Comparison: Barclays World Government inflation-linked Index hedged in USD vs Barclays Breakeven Index hedged in USD
Historical performance indications and financial market scenarios are no guarantee for current or future performance Source: Credit Suisse, Bloomberg, Barclays Capital
Asset Management
Inflation-Linked Bonds Slide 5/18
Which market conditions favour ILB?
Real interest rates Inflation expectations
Real interest rates Inflation expectations
Real interest rates
No change in real interest rates No change in expected inflation
Same performance of inflationlinked and nominal bonds. Both outperform cash.
No change in real rates
Inflation-linked bonds outperform
Rising inflation expectations
nominal bonds and cash.
No change in real rates
Inflation-linked bonds
Falling inflation expectations
underperform nominal bonds.
Rising real rates
Same performance of inflation-
No change in expected inflation
linked and nominal bonds. Both
No preference
Best case
Worst case
Inflation expectations
Real interest rates
No preference
underperform cash.
Inflation expectations
Source: Credit Suisse
Asset Management
Inflation-Linked Bonds Slide 6/18
Solution 2: Money market investments (Switzerland) 4%
Real money market rate*
3% 2%
10
20
07
20
04
20
01
20
98
19
95
19
92
19
89
19
86
19
83
19
80
19
77
19
74
19
71
19
68
19
65
19
62
19
-2%
19
19
56
-1%
59
1% 0%
-3% -4% -5% -6%
1.
Since 1956, the average real rate of return was 0.05%
2.
Negative return for 36% of the time
3.
Periods of prolonged negative real interest rates (1970s)
* measured as the discount rate prevailing at the beginning of the year minus the inflation rate
Asset Management
Source: SNB, Bloomberg, Credit Suisse
Inflation-Linked Bonds Slide 7/18
Solution 3: Synthetic inflation-linked bonds
Combination of conventional bonds together with inflation swaps to build synthetic inflation linked bonds
Inflation protection without the sub-optimalities associated with inflationlinked bonds
Benefits:
ILB bond portfolio available in CHF Increased diversification as no restriction to inflation-linked bonds Increased yield by adding defensive corporate bonds Flexible and cost effective solution as no allocation change of the existing bond portfolio warranted
Customized benchmark possible Precise measure of inflation risk in the portfolio Source: Credit Suisse
Asset Management
Inflation-Linked Bonds Slide 8/18
Synthetic inflation-linked bonds – Description
Bond + inflation-swap = synthetic inflation-linked bond
Principal Pay Fixed Receive Inflation Nominal Coupon
we combine bonds denominated in CHF with swaps on European and US inflation. This represents a proxy hedge that works as long as inflation surprises in these markets are correlated with Swiss inflation. Source: Credit Suisse
Asset Management
Inflation-Linked Bonds Slide 9/18
Measuring the interest rate risk – Dual Duration
We can distinguish two types of durations:
– real rate duration: sensitivity with respect to changes in the real rates – Inflation duration: sensitivity with respect to changes in inflation expectations
For nominal bonds: nominal duration = real duration = inflation duration
For inflation-linked bonds: nominal duration = real duration, inflation duration = 0
To compare nominal bonds with inflation-linked bonds often an equivalent nominal duration for ILB is calculated: nominal duration of inflation-linked bonds = real duration * beta (with beta normally assumed to be = 0.5)
The dual duration is the more precise measure as beta is not constant, varies across maturities and has the tendency to be directional Source: Credit Suisse
Asset Management
Inflation-Linked Bonds Slide 10/18
Dual Duration – Real interest rate duration Every cashflow is flagged as real and/or inflation linked Î Clear separation of the two interest rate dimensions Real Duration Density
Cumulated Real Duration Density
1
5
Portfolio Benchmark
Portfolio Benchmark
4.5
0.8 Spot cumulated Duration Density
Spot Duration Density
4
0.6
0.4
0.2
0
3.5 3 2.5 2 1.5 1 0.5
-0.2
0
5
10
15
Tenor [years]
0
0
5
10
15
Tenor [years] Source: Credit Suisse
Asset Management
Inflation-Linked Bonds Slide 11/18
Dual Duration – Inflation duration Inflation Duration Density
Cumulated Inflation Duration Density
1
5 Portfolio Benchmark
0.8
Portfolio Benchmark
4.5
Spot cumulated Duration Density
4 Spot Duration Density
0.6
0.4
0.2
0
-0.2
3.5 3 2.5 2 1.5 1 0.5
-0.4
0
5
10
15
Tenor [years]
0
0
5
10
15
Tenor [years]
Source: Credit Suisse
Asset Management
Inflation-Linked Bonds Slide 12/18
Appendix
Asset Management
Inflation-Linked Bonds Slide 13/18
Yield curve decomposition Nominal bonds react to movements in nominal interest rates independently from the source
Expected inflation Risk premium
Break-even inflation Real rate
Interest rates
Nominal rate
of the change, i.e. real rates or breakeven inflation. Real bonds (ILB) react only to changes in real interest rates and are immune (protected) against changes in inflation expectations.
Source: Credit Suisse
Asset Management
Inflation-Linked Bonds Slide 14/18
Inflation-linked bond – non-accreting structure Non-accreting structure Maturity of the bond: 10 years Coupon: 3% (real coupon) Type: non-accreting structure, i.e. adjustment of coupons only Very few issues outstanding, mostly supranational bonds
Year
Inflation
Notional
Coupon
1 2 3 4 5 6 7 8 9 10
1.5 1.8 1.3 1.9 2.2 2.5 2.8 3.2 2.8 2.7
100 100 100 100 100 100 100 100 100 100
4.5 4.8 4.3 4.9 5.2 5.5 5.8 6.2 5.8 5.7
7.0 120 6.0 100
5.0
80
4.0
60
3.0 2.0
40
1.0
20 0
0.0 1
2
3
4
5 Coupon (lhs)
Source: Credit Suisse
6
7 Inflation (lhs)
8
9
10
Notional (rhs)
Graphs are just calculation examples
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Inflation-Linked Bonds Slide 15/18
Inflation-linked bond – accreting structure Accreting structure Maturity of the bond: 10 years Coupon: 3% (real coupon) Type: accreting structure, i.e. adjustment of the notional only Market standard, most government bonds have an accreting structure
Year
Inflation
Notional
Coupon
1 2 3 4 5 6 7 8 9 10
1.5 1.8 1.3 1.9 2.2 2.5 2.8 3.2 2.8 2.7
101.5 103.327 104.6703 106.659 109.0055 111.7306 114.8591 118.5346 121.8535 125.1436
3.045 3.100 3.140 3.200 3.270 3.352 3.446 3.556 3.656 3.754
7.0 120 6.0 100
5.0
80
4.0
60
3.0 2.0
40
1.0
20
0.0
0 1
2
3
4
5
Coupon (lhs)
Source: Credit Suisse
6
7
Inflation (lhs)
8
9
10
Notional (rhs)
Graphs are just calculation examples
Asset Management
Inflation-Linked Bonds Slide 16/18
Inflation differential – Switzerland vs. France and the USA Average Standard deviation Correlation to Swiss inflation
France
USA
EMU (since 1998)
-2.07% 3.46% 0.5
-1.17% 2.55% 0.54
-0.97% 0.60% 0.81
5
0
-5
-10
-15
-20 56575859606162636465666768697071727374757677787980818283848586878889909192939495969798990001020304050607080910
Swiss minus French inflation Swiss minus US inflation
Last date point: December 2009
Swiss minus EMU inflation
Source: Bloomberg, Credit Suisse, OECD
Asset Management
Inflation-Linked Bonds Slide 17/18
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Asset Management
Inflation-Linked Bonds Slide 18/18
