BearBull Group Research: End of the Inversion of Swiss Yield Curve in 2025

Key Points:

• Swiss GDP growth is accelerating significantly
• Swiss exports have been declining since April
• Leading indicators remain uncertain
• Inflation will temporarily fall below 1%
• The SNB will lower rates by another 0.25% in September
• It’s unlikely to bet on a very weak franc
• The decline in long-term interest rates is nearing its end
• Outlook for Swiss equities remains positive

Swiss GDP growth is accelerating significantly

Swiss GDP growth for the second quarter has been published, showing much more than just resilience from the national economy in an uncertain international and European context. The Swiss economy grew by +0.7% before the summer and +0.5% adjusted for sporting events in Q2, bringing the annual growth to +1.8%. This is the strongest quarterly growth since Q2 2022 (+1%), when annual growth was +3.9%. The GDP growth reported by SECO follows an accelerating trend, exceeding the historical average. The Swiss economy has thus strengthened its growth pace, with the manufacturing sector appearing less affected by the exchange rate, which declined by -7% against the dollar in the first half of 2024. The monetary policy shift by the Swiss National Bank (SNB), including the first rate cut in March 2024, contributed to a weakening franc and supported positive economic prospects.

Interestingly, Switzerland's economic dynamics are no longer as affected by global demand and exchange rates in the second quarter. While the manufacturing sector is not yet out of trouble, the PMI indicator has suggested a potential improvement for months. Meanwhile, the service sector has rebounded sharply from 44.7 to 52.9, offering a far more optimistic outlook in early September.

The end-of-June analysis from SECO's data shows robust expansion in the chemical and pharmaceutical industries, with a remarkable +8.4% growth driven by dynamic exports. Manufacturing value creation was surprisingly strong with a +2.6% increase, higher than the average. However, value creation in other industrial sectors declined, reflecting tough situations in Switzerland's European partner countries. Domestic demand was relatively weak, with a notable -1.4% drop in capital goods investments. Construction investments remained moderate at +0.5%, while consumption saw a modest increase. Private consumption grew only by +0.3%, below the average, while public consumption contributed just +0.2% to growth.

Swiss GDP in millions of CHF (quarterly data)

The stagnation of domestic demand has resulted in slow value creation in the service sector, with significant variation across industries. Value creation in the hospitality sector improved due to an increase in both foreign and Swiss travelers (+2.7%). The healthcare and social services sector (+1.1%), business services (+0.6%), and public administration (+0.3%) also saw positive growth. However, the transportation and communication sector stagnated (0%), while financial services (-0.2%), retail trade (-0.4%), and overall commerce (-1.2%) experienced moderate declines.

Merchandise exports showed strong growth (+6.9%), while service exports increased slightly (+1.5%). Overall, foreign trade was a key driver of GDP growth in the second quarter, as the weakness of the Swiss franc provided a competitive edge for Swiss products and some flexibility for exporting companies. Unfortunately, this currency weakness was only temporary, and the trend reversal in April had a negative impact on these companies in the following months.

Swiss exports have been declining since April

After a strong April, with a 7.3% increase in exports, the following three months proved challenging for Swiss exporters, who saw consecutive declines in their sales. Late April marked the weakest point for the CHF/USD exchange rate, with the franc declining by 9.2%. Despite a more accommodative monetary policy from the SNB since March and a further interest rate cut in June, the Swiss franc regained lost ground, particularly following the shock reversal of speculative carry trades on the yen in early August, which similarly impacted the franc.

The return to 0.84 CHF per USD in the third quarter is clearly not favorable for Swiss exporters and the competitiveness of the Swiss industry. This is reflected in the external trade situation, with Swiss exports dropping by 1.8% in July. The exporting sector is struggling, as evidenced by international watch sales growing by only 1.6% year-on-year in July, far below the average growth of around 10% seen in 2022-2023. Meanwhile, imports showed no growth in July (0%). The trade balance may suffer from these trends, although it still reported a positive result of 59.5 billion dollars at the end of June, a significant increase from 53.4 billion dollars on December 31, 2023.

Swiss trade balance, imports and exports

Leading indicators remain uncertain

The latest leading indicators published for August remain highly uncertain. Consumer confidence, as measured by the State Secretariat for Economic Affairs, remains very low in August (-34.6) without showing tangible signs of improvement. At the end of 2021, the measure was still positive (3.5) before a sharp decline in 2022 brought it down to -46. Although there has been some improvement in the past two years, the indicator remains at an extremely worrying level. Despite falling inflation and the start of a more accommodative monetary policy, consumer confidence remains depressed, which threatens the level of household consumption, which has still been relatively resilient this past quarter.

PMI and KOF indicators

Industrial production

The outlook is slightly better for the KOF index, which has risen to 101.6, indicating overall stagnation since the beginning of the year without clear signs of recovery. Instead, attention should be directed towards the PMI manufacturing index (49) and the PMI services index (52.5) for potential early signs of improvement in economic dynamics. Both indicators have significantly rebounded from their lows, suggesting better prospects. In the short term, retail sales also rebounded in August following a significant drop in June (-2.6) over twelve months. Industrial production notably strengthened in the second quarter, rebounding from -3.3% to +6.4% year-on-year. Overall, traditional leading indicators remain uncertain, likely still impacted by the ongoing hesitant global economic environment and the recent appreciation of the franc.

Inflation will temporarily fall below 1%

Swiss inflation reached its low point for 2024 in March with an annual increase of just +1% before rebounding to +1.4% in April and May. At that time, the Swiss National Bank (SNB) decided it was appropriate to lower interest rates by 0.25%, initiating a new cycle of policy normalization. We had anticipated that this CPI rebound would not be sustainable and that the downward trend in prices would continue. The most recent data for August supports this, as the Consumer Price Index (CPI) is near its low, at only +1.1% year-on-year, with no change from the previous month. Since the beginning of the year, the CPI has seen only four monthly increases, with the last three months showing an average inflation rate of barely -0.066%. We estimate that the overall CPI may end 2024 with a persistently low or even negative monthly rate, though it will likely be challenging to bring the annual CPI significantly below 1%.

Regarding core inflation (excluding food and energy), the trend is similar, with the core index increasing by +1.1% over eight months and +0.1% over the most recent month.

In terms of imported prices and producer prices, the situation is even more favorable. The overall index also showed no change in July, but on a year-over-year basis, prices have declined by -1.7%. This represents the fifteenth consecutive negative measure since May 2023. The Swiss economy has thus been in deflation for over a year in this regard, which is a positive factor for both the CPI and company profit margins.

CPI and PPI - Switzerland

Inflation in Switzerland clearly benefited from the appreciation of the franc in 2023. There is indeed a correlation between a stronger franc and lower imported inflation. However, recent fluctuations in the Swiss currency against the dollar, first decreasing and then increasing, have not had the same impact in 2024. The Swiss National Bank's policy shift, following its success in controlling inflation, implies a probable depreciation of the franc. The stabilization of producer prices allows for a more positive outlook for future consumer price trends. Inflation is expected to temporarily fall below the 1% threshold.7

The SNB will lower rates by another 0.25% in September

Inflation is indeed under control in Switzerland, and recent statistics do not raise concerns about a potential rebound. With only a few months remaining in the year, the Swiss National Bank's inflation forecast of +1.4% might even be considered too conservative given the current rate of just +1%. Inflation has entered the desired fluctuation band and no longer requires strong corrective action from the SNB, which can accommodate this level of inflation. However, the SNB may also prefer not to see a sharp continuation of this trend, which could potentially lead to deflationary pressures in Switzerland. Although this risk seems distant, especially if the recent strength of the franc continues, the SNB has significant room to maneuver before its meeting on September 26.

One crucial factor is the recent appreciation of the Swiss franc, which has strengthened by about +9% against the dollar and +6% against the euro. This appreciation over the past three months has likely contributed to maintaining a near-zero inflation rate in the country, and could continue to influence indicators for a few more months. The SNB may not view the franc’s appreciation favorably if it leads to deflationary risks. The still uncertain economic indicators, particularly in the industrial sector and consumer confidence, add to the complexity.

The SNB might need to consider the extent of any interest rate cut to curb the franc's appreciation and whether intervention through franc sales and currency purchases might be necessary. Although a 0.5% rate cut in September seems unlikely, the success of the SNB’s inflation control could make it a possible but still estimated at a 50% probability.

It’s unlikely to bet on a very weak franc

The strength of the franc certainly peaked at the end of December 2023, and the expected period of weakness materialized as the SNB announced its policy shift. However, it is also likely that the decline in Swiss interest rates will reach its nadir more quickly in a few months, while the cycles of the ECB, Fed, and BoE may be longer. The yield differentials are expected to contract logically, which would be a positive factor for the franc.

Exchange rates and SNB reserves

But after reducing the size of its balance sheet to 2017 levels, the SNB now has the means to influence the exchange rate. In this context, while franc weakness still seems likely, we no longer anticipate a decline as significant as initially expected at the beginning of the year. The franc is nonetheless expected to weaken by 5 to 7% against the dollar and the euro over the coming months.

The decline in long-term interest rates is nearing its end

For the past two years, inflation has been under control in our country, and monetary policy has adjusted to this new paradigm by lowering interest rates starting in March. Our target for interest rates is 0.75%, which should imply two more rate cuts in September and December. During this period of declining inflation, the downward trend predicted by BBGI for long-term Confederation rates has materialized, decreasing from 1.6% in March 2023 to 0.34% in August 2024. Our forecasts for declining inflation and changes in monetary policy have also come to fruition, leaving little room for further significant movements. We estimate that if inflation falls below 1% year-over-year, the SNB's interest rates could be lowered to 0.75% in a gradual flattening of the yield curve. In this context, the current level of long-term Confederation rates could also rise towards a 0.75% target. Therefore, prospects for capital gains on Swiss franc bonds are increasingly limited, and the recent development of Swiss yields offers little interest.

Confederation rate curve

Outlook for Swiss equities remains positive

Swiss stocks have shown significant progress in 2024, with a rise of +10.6%. However, they lag behind the performance of American equities (S&P 500 +18% in USD) and are on par with European companies (+7.2% in EUR). The weakness of the Swiss franc in the first half of the year supported the Swiss market, but the results of other stock markets benefited from currency effects that strengthened their results when expressed in Swiss francs. Since the end of June, the rebound of the franc has not specifically impacted our market, with Swiss stocks rising by +0.5% amid global uncertainty and increased volatility due to the reversal of "carry trade" positions (SPX +3%, Stoxx50 -0.9%, FTSE100 +1.4%). As a result, the Swiss market has underperformed international stocks in 2024, but to a lesser extent.

The recent decline in Swiss exports reflects the challenges posed by the relative strength of the franc for Swiss companies. Upcoming rate cuts and the end of Swiss franc purchases by the SNB are expected to weaken the franc. This should lead to a reevaluation of earnings prospects and support the continuation of the current upward trend. Therefore, the outlook for the Swiss market remains positive for the end of 2024, especially for smaller, interest-sensitive stocks, which are expected to outperform "blue chips." However, the relatively high P/E ratio of Swiss stocks (22x for the SMI) could potentially hinder the appreciation of stock indices, making their positive outlook less favorable compared to other developed markets.

Swiss stock indices