Swiss bonds remain attractive

The main risk of negative interest rates is that investors are increasingly willing to increase their risk exposure in search of returns. In Switzerland, however, this scenario is not an immediate threat: the current figures argue against further interest rate cuts by the SNB. Inflation is trending slightly upwards, as predicted by the National Bank. The real, trade-weighted franc has also been relatively stable over recent months. There are currently no signs of major safe-haven inflows, which would create upward pressure. Nevertheless, negative interest rates are unlikely to be completely off the table. The uncertainty surrounding US import tariffs remains high, as does therefore the economic risk for Switzerland.

For the eurozone, Swiss Life Asset Managers’ model calculations show that the neutral interest rate level has more or less been reached. In the USA, on the other hand, central bank interest rates are still in restrictive territory, with four further key interest rate cuts expected. But as long as there is no recession – which we assume – the Federal Reserve will not lower the US key interest rate to 2.5% or below. As a result, long-term interest rates in the USA are likely to trend sideways. In Switzerland, the neutral interest rate level is slightly higher than the current key interest rate. This suggests that market interest rates are likely to rise gradually in the coming years.

The weakness of the dollar reflects increased economic-policy risks, making the greenback less attractive as a reserve currency; this is a gradual process, however. Accordingly, Swiss Life Asset Managers does not expect the term premium (the premium charged on the market for longer maturities) to widen significantly in the foreseeable future. However, due to the difficult fiscal situation and rising debt burden, we do not anticipate a return to the recent lows any time soon.

For investors, the current situation is textbook: on the one hand, those who opt for longer maturities receive a higher interest rate. On the other hand, so-called roll-down profits can also be achieved by investing in the steepest parts of the yield curve, which benefit particularly from positive valuation changes.

Internationally, the Swiss franc bond market is more attractive than it appears at first glance. Absolute interest rates remain low, but Switzerland offers more favourable spreads: credit-adjusted premiums over the risk-free interest rate are higher than abroad. This is particularly true for investment-grade bonds, i.e. those with good credit ratings. In Switzerland, foreign issuers pay a premium of over 70 basis points compared to Swiss government bonds. In the eurozone, the premium over risk-free German government bonds is just under 80 basis points – similar to that offered on US Treasuries. However, the Swiss investment-grade (IG) credit segment carries significantly lower risk than its counterparts in the eurozone and the USA. More than 40% of the foreign segment in the Swiss franc market is invested not in corporate bonds, but in government bonds, bonds issued by supranationals and government agencies, and mortgage bonds. These are all issuers with high credit quality. As a result, investors benefit from a portfolio with much better creditworthiness at an almost equivalent spread level.

In Switzerland, the spread is slightly below the historical average. By contrast, in the eurozone and the USA, as measured by the euro and US investment-grade indices, spreads are at their tightest levels since the financial crisis. In the same rating segment of US dollar-denominated corporate bonds issued by emerging markets, spreads are currently at an all-time low.

There are good reasons for this: corporate balance sheets are healthy, and conditions have improved markedly, particularly in emerging markets. Nevertheless, these are aggressive valuations, and investors must additionally factor in the costs of exchange rate hedging. Hedging costs are high due to the large interest rate differential between the US dollar and the Swiss franc. Ten-year Swiss government bonds yield around 0.4% more interest than equivalent dollar bonds after currency hedging. And Switzerland is clearly the safer investment. Institutions are stable and debt is much lower. In times of crisis, capital tends to flow in rather than out.

The domestic segment is dominated by a few large providers: the Swiss Confederation, mortgage bond institutions, cities and cantons. The corporate bond market is comparatively small. With the exception of Swiss government bonds, we find these issuer categories attractive in the current environment.

Currently, we consider real returns to be attractive, particularly when compared with the negative interest rate environment that followed the financial crisis, when real returns remained negative for extended periods in many developed countries. The challenge with real returns is this: you only ever find out in hindsight whether a bond investment has generated a positive return, after accounting for actual inflation. The only exception is investments in inflation-linked bonds, which are primarily issued by governments. For institutional investors, bonds are an essential investment for asset and liability management. However, private investors should be aware that yields on Swiss franc bonds have once again fallen below 1%. Investments in mortgages appear more attractive in this context. They currently generate returns of more than 100 basis points higher than Swiss Confederation bonds and also offer protection against negative interest rates. This is because the base rate on which mortgage institutions add their margin generally has a lower limit of zero.