Switzerland's central bank bet it all, lost big and is now making record profits on a wager that buying hundreds of billions of dollars in foreign stocks and bonds would weaken the Swiss franc.
Now the $750 billion bet is paying off, the bank faces a new dilemma: it can't cash in any of its paper winnings. Selling some of its stocks and bonds and bringing the money home would likely boost the franc's value, hurt exporters and undermine the cornerstone of Switzerland's monetary policy.
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However, doing nothing exposes the central bank to future losses if stock and bond prices fall.
The Swiss National Bank said Tuesday that its third-quarter profit was a record-high 32.5 billion Swiss francs ($32.7 billion). It is a staggering sum for a country whose population is roughly 8.5 million, equal to about 5% of its gross domestic product. In contrast, the Federal Reserve's $93 billion profit for 2016 only equaled about 0.5% of U.S. GDP.
The SNB's profit was lifted by a trio of positive forces: low bond yields preserved the value of its foreign bonds; higher equity prices raised the value of SNB holdings that included $2.8 billion in Apple Inc. stock at the middle of 2017 and $1.3 billion in Facebook Inc. and the weaker Swiss currency made those foreign assets worth more in franc terms.
For the first nine months of 2017, the SNB's profit was 33.7 billion francs. Of that, over 14 billion francs was from rising equity prices and another 10.5 billion francs came from the valuation effects of the weaker franc, which fell around 5% against the euro last quarter. It also earned money from its bond and gold portfolio.
The SNB's three-person governing board sets out the broad investment strategy annually, including the currency breakdown and the stock-bond weighting. In-house portfolio managers oversee these funds from Switzerland and an SNB branch in Singapore. The SNB's equity investments--which comprise 20% of its foreign assets--replicate broad indexes. The rest of its investments are in foreign government and other bonds.
The SNB accumulated its huge reserves after years of foreign-exchange interventions, particularly during Europe's debt crisis, in which it created francs and used them to purchase foreign assets in a bid to weaken the currency. Its foreign-currency assets were around 100 billion francs at the start of 2010. They were nearly 750 billion francs by August 2017.
Still, these efforts failed to weaken the franc for many years. In January 2015, the SNB abandoned a floor in the euro-franc rate, causing the franc to soar in value. As a result, the SNB lost 50 billion francs in the first half of 2015.
However, in the last quarter, the euro strengthened and the dollar also firmed. The SNB wins twice when that happens. A weaker franc boosts exports and makes it easier for the SNB to get inflation higher. And it raises the value of its foreign assets.
Yet the SNB's hands are tied on what it can do with its profits. Whereas central banks like the Federal Reserve transfer most of their profits to their governments, the SNB is in the early stages of a five-year profit-sharing arrangement whereby the maximum amount it can transfer to the Swiss federal and regional governments is just two billion francs a year.
That agreement runs until 2020. It also pays a small amount--1.5 million francs annually--to its private shareholders. SNB shares were up 0.6% in early trading Tuesday.
Therefore, some of the SNB's profits this year will probably go to its capital provisions with the rest being carried over into 2018.
The continued weakening of the franc should bolster the SNB's bottom line this quarter, too. The euro has strengthened another 1.5% against the franc in October and the dollar rose about 3%. The euro fetched 1.16 francs early Tuesday. The dollar traded at 0.9965 francs.
The SNB's euro and dollar assets account for three-quarters of its war chest of foreign-currency investments, so even a small weakening of the franc translates into billions of francs in paper profits.
Write to Brian Blackstone at email@example.com
(END) Dow Jones Newswires
October 31, 2017 05:22 ET (09:22 GMT)