DB Swiss Special Report-2

Deutsche Bank Markets Research

Global

Special Report

Economics Foreign Exchange FX Spot

Date 27 January 2015

Swiss Miss: What Next?

________________________________________________________________________________________________________________

Deutsche Bank Securities Inc.

DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 148/04/2014.

Oliver Harvey

Macro strategist (+44) 20 754-51947

[email protected]

Robin Winkler

Strategist (+44) 20 754-71841

[email protected]

The SNBs decision to discontinue the exchange rate floor this month led

to turmoil and consternation in FX markets. As the dust settles, we provide a first assessment of the implications for CHF and wider financial markets.

The Swiss franc now stands significantly overvalued on a wide range of valuation metrics. Based on our proprietary models as well as external fair value estimates, we think that CHF is ~30% overvalued against EUR and USD. The real effective exchange rate is similarly overvalued.

Contrary to a popular belief, safe haven capital inflows ceased two years ago. The franc has since been strengthened by the drying-up of Swiss outflows. As foreign assets are cheaper post-appreciation and Swiss yields the lowest globally, Swiss portfolio outflows should pick up eventually.

The effect of the appreciation on the current account should be mitigated by the large contribution of income flows to the surplus and relatively low trade elasticities. Nevertheless, we expect Switzerlands current account to deteriorate as a result of appreciation.

On the policy side, the SNBs decision is best explained by a prioritization of financial stability over price stability. Looking ahead, the SNB will want to minimize deflation tail risks by resisting further franc appreciation. Unless the central bank is willing to commit to truly imposing negative rates on domestic savers, however, it may find its ability to influence monetary conditions hamstrung.

The SNBs surprise decision will have implications beyond Switzerland. Despite concerns, the francs use as a global funding currency is relatively limited. Eastern European countries with large financial exposures should also be able to weather the appreciation. The main loser will be financial industry. For policy, the SNBs decision sets a negative precedent for the credibility of extraordinary monetary policy, and could begin to undermine confidence in the sustainability of other pegged exchange rate regimes.

The SNB caused the largest FX intraday movement in the post-Bretton Woods era

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Intra

day r

ange

/ 12-

mon

t st.

dev

Intraday range

USD/IDR:Asian debt crisis31 Dec 1997

USD/RUB:Russian debt crisis:15 Sep 1998

USD/MXN:Tequila crisis:22 December 1994

USD/KRW:Asian debt crisis30 Dec 1997

USD/ARS:Argentine pegging14 Jan 1991

USD/TRY:Turkey crisis22 March 1991

USD/THB:Start of the Asian crisis2 Jul7 1997

Source: Deutsche Bank, Bloomberg Finance LP

EUR/CHF: SNB pulls floor 15th Jan 2015

27 January 2015

Special Report: Swiss Miss: What Next?

Page 2 Deutsche Bank Securities Inc.

Background

On Thursday 15th January, the SNB discontinued its policy of maintaining the Swiss franc above 1.20 to the euro. The SNB introduced the floor in 2011, at the height of the sovereign debt crisis in the Eurozone. Over the preceding years, the Swiss franc had appreciated as a result mainly of capital inflows from Europe in search of a safe haven. Yet even as European risk premia declined, appreciatory pressure on CHF did not subside, with the SNB continuing to print money and accumulate foreign reserves.

The SNBs decision to abandon the floor created a truly historic market dislocation. Placed in context, the resulting appreciation of the Swiss franc created the third largest intra-day range in any major currency pair in the post-Bretton Woods era. When normalized by the currencys typical volatility, however, the move can lay a claim to be the largest ever.

The reason why On 18 December, after cutting the rate on sight deposits to -0.25%, SNB chairman Thomas Jordan stressed:

The minimum exchange rate remains key to ensuring appropriate monetary conditions in Switzerland. This is why we remain committed to enforcing the minimum exchange rate with the utmost determination. To this end, we are prepared to purchase foreign currency in unlimited quantities and to take further measures, if required. Without the minimum exchange rate, price stability in Switzerland would be seriously compromised.

What led to the sudden change of mind? Jordan provided two reasons. First, he argued that CHF had lately become less overvalued against USD in particular. Second, he claimed that any remaining appreciatory pressure on the currency would be mitigated by the cut in the marginal interest rate to -0.75%.

These rationales are unconvincing. First, while the Swiss franc had indeed converged closer to its fair value against the dollar since the introduction of the exchange rate floor, the decision must have been taken with regard to the counterfactual of where the franc would settle following the decision. The unremitting need for the SNB to purchase foreign reserves at the 1.20 floor was a clear warning that market pressure had not abated. Second, the rate cut to -0.25% in December relieved almost none of that pressure. Because of this,

January 15 saw the largest FX intraday movement in the post-Bretton Woods era

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Intra

day r

ange

/ 12-

mon

t st.

dev

Intraday range

USD/IDR:Asian debt crisis31 Dec 1997

USD/RUB:Russian debt crisis:15 Sep 1998

USD/MXN:Tequila crisis:22 December 1994

USD/KRW:Asian debt crisis30 Dec 1997

USD/ARS:Argentine pegging14 Jan 1991

USD/TRY:Turkey crisis22 March 1991

USD/THB:Start of the Asian crisis2 Jul7 1997

Source: Deutsche Bank, Bloomberg Finance LP

EUR/CHF: SNB pulls floor 15th Jan 2015

27 January 2015


Deutsche Bank Securities Inc. Page 3

it is difficult to believe the SNB concluded that monthly FX purchases of more than CHF 5bn on average could seamlessly be replaced by a one-off 50bps rate cut on a tenth of Swiss sight deposits.

In reality, the reasons for the discontinuation of the floor probably stemmed from the SNBs prioritization of financial stability over price stability. The SNB continued to have policy options available to defend the floor before the decision, either through open ended FX intervention or through further cuts to the deposit rate and/or a reduction of the cap over which the negative deposit rate was applied to excess reserves. As we argue below, the SNBs reluctance to embrace the latter likely stemmed from their unwillingness to charge domestic depositors for their savings and their concern that this could reinforce asset price dislocations in the country. Balance sheet risks were likely to be a secondary concern given that the central bank realized an immediate loss of nearly 20% on its foreign exchange reserves.

With the SNBs decision certain to cause a significant deflationary shock (according to estimates below, perhaps greater than during the 2008-2009 financial crisis) this raises the question as to whether the central bank have reneged on their mandate of price stability. In fact, the SNB define price stability simply as inflation of less than 2% per annum. However, the central bank acknowledges that the mandate is in essence quite symmetric, since both inflation and deflation would hamper economic development. The articles of incorporation clearly place the consideration of financial stability as subsidiary to the overarching framework of price stability.1 This concern should make the central bank acutely sensitive to any significant deterioration in economic performance over the coming months, given the potential for it to generate public criticism.

1Article 5 of the Federal Act on the SNB states that: The National Bank shall pursue a monetary policy serving the interests of the country as a whole. It shall insure price stabilityWithin this framework, it shall have the following tasks:It shall contribute to the stability of the financial system. See: http://www.snb.ch/en/mmr/reference/snb_legal_NBG_01_01_07/source/NBG_ab_01.01.07_en.pdf

27 January 2015



Where next for the Swiss franc?

As the dust settles, attention is now turning to where the franc moves next. In the short term, the market is still recovering from a considerable trauma and it will take time before a normal price discovery process is resumed. Spreads in USD/CHF have averaged 0.41% in the last three days, 10 times wider than their 2014 average.

Adjustment will be made more difficult by the considerable CHF short position investors had built up over the course of the last few months. IMM data show that shorts were close to record highs in the week before the SNB decision. Our proprietary flow report also shows that volumes in USD/CHF had ramped up considerably in the weeks prior to the decision, likely as a result of investors shifting into CHF as an alternative for EUR funding for long dollar positions.

It will take time for this positioning to be fully washed out as investors reflect on whether to take advantage of the limited liquidity now available in the market or wait for an improvement in liquidity conditions and better entry levels. The widespread use of CHF funding for loans, retail and structured products outside the ken of the FX investor community will also take time to resolve. The extent of market dislocation is clearly evident in the Swiss money market curve which has collapsed as a result of investors desperately trying to move out of paying rates positions. Implied yields on short dated USD/CHF forwards are at even more extreme levels. The 1 month implied USD/CHF yield currently stands at -2.25%.

With EUR/CHF having hugged the 1.20 floor for more than three years, there is little guidance about where fair value should now lie. The easiest place to start in providing an estimate of fair value is fundamental exchange rate valuation, which is our first calling point below.

Notwithstanding the difficulties suffered by investors over the previous few days, we are inclined to believe that the next medium term move in the franc will be lower rather than higher against the euro and the dollar. This is based on an overall assessment of valuation, the prospect of deterioration in the Swiss balance of payments and the desire of the SNB at least to limit the prospect of deflationary tail risks.

CHF shorts at multi-year highs beforehand And volumes had ramped up as well

0%

20%

40%

60%

80%

100%

120%

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

1.10

1.15

Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15

Weekly volumes (5 year percentile, rhs)

USD/CHF

Source: Deutsche Bank, Bloomberg Finance LP Source: Deutsche Bank, Bloomberg Finance LP

27 January 2015



The franc is now extremely overvalued On a simple PPP basis, the franc was already significantly overvalued against both the euro and the dollar prior to its sudden appreciation on 15 January. Deutsche Bank PPP estimates suggest that fair value lies at 1.35 and 1.17 in EUR/CHF and USD/CHF, respectively. At the time of writing, the franc is thus 33% and 35% overvalued against the euro and dollar, respectively. Relative to history, the francs current overvaluation is large. The franc is the most overvalued in history against the euro and close to its all time overvaluation extreme against the dollar in 2011. It is also rare for the currency to deviate beyond a 20% overvaluation or undervaluation extreme against the euro.

Of course, PPP is not the only measure of fair value, and even different PPP methodologies yield discrepant results. The most objective way of looking at CHF valuation, therefore, is to aggregate different estimates of CHF fair value from our proprietary models and external sources. Strikingly, using a broad basket of valuation methodologies yields a surprisingly narrow valuation range, especially for EUR/CHF.

Our BEER valuation measure, which adjusts relative prices for terms of trade and productivity effects, suggests that fair value lies at least 20% above the current spot rate against both the euro and dollar. Our FEER valuation model, based on long-run estimates of sustainable external balances, shows the franc to be similarly expensive. It is unusual for a currency to be so significantly overvalued on all three of our valuation models. The BEER and FEER models are designed to account for precisely those factors which tend to push exchange rates away from purchasing power parity. For example, Switzerlands very large current account surplus, which has caused some commentators to argue that the franc was artificially undervalued against the euro, would be captured by the FEER methodology. Yet this accounts for only a few percentage points of the francs valuation. In all our models, CHF is now the most overvalued currency in the G10 space.

Turning to external sources, the franc also looks very expensive relative to real effective exchange rates calculated by the BIS and the IMF. The IMF considered the franc modestly overvalued at the time of its Article IV consultation with Switzerland in 2013. The IMFs fair value estimates of March 2013 imply a current overvaluation in close proximity to our own results. Finally, the SNBs own estimate of franc overvaluation in October of last year implies that today the franc is around 30% and 19% overvalued against the euro and the dollar, respectively.2

2 SNB vice-chairman Danthine suggested a PPP fair value of 1.28-1.30 against the euro in October 2014. http://www.bloomberg.com/news/2014-10-09/danthine-says-snb-hasn-t-intervened-to-defend-ceiling-in-months.html

The Swiss franc is now significantly overvalued on all metrics

Current value 127 Current value 1.02 Current value 0.87Valuation method Fair value Overvaluation Fair value Overvaluation Fair value OvervaluationDB, PPP --- --- 1.35 33% 1.17 35%DB, REER, 10Y average 100 28% --- --- --- ---BIS, REER, 10Y average 98 29% --- --- --- ---DB, FEER 102 25% 1.27 26% 1.06 21%DB, BEER 92 37% 1.30 29% 1.04 19%SNB, PPP1 --- --- 1.28-1.30 29-31% 1.02-1.04 18-20%IMF, REER2 93-98 31-38% --- --- --- ---

vs EUR vs USDvs REER

Source: Deutsche Bank, Bloomberg, IMF, BIS

27 January 2015



CHF not the safe haven it seems Contrary to received wisdom, safe haven inflows do not provide a particularly convincing explanation for recent CHF strength. Switzerland did indeed see extremely large safe haven inflows during the crisis years of 2008-9 and 2011-12. This is clearly shown in the balance of payments where net other investment flows, which measure loans and deposits and are a proxy for safe haven demand, skyrocketed.

If these other investment inflows were added to Switzerlands basic balance, commonly used by economists to measure the overall capital flow picture of countries, they would push overall capital inflows into the country to a staggering 30% of GDP over those years (see charts).

Since 2012, however, Switzerland has recorded negative net other investment flows. Swiss banking statistics show that foreigners have been reducing, not increasing, CHF denominated deposits in both foreign and domestic bank accounts. This should not be surprising given the fall in Eurozone risk premia. Neither do the banking statistics support the thesis that recent geopolitical risk has generated a surge in Swiss deposits recently, although Q4 balance of

EUR/CHF had slowly been converging with its PPP fair

value

CHF now the most overvalued G10 currency

02468

1012

CHF

NZD

AUD

GBP

CAD

EUR

USD

NOK

SEK

JPY

PPP

BEER

FEER

Average

Rank of valuation vs. USD. Further from the centre equals most expensive vs. USD

Decreasing overvaluation


Safe haven inflows until 2012 have reversed since then Safe haven inflows were large relative to basic balance

-40%

-30%

-20%

-10%

0%

10%

20%

30%

Oct-99 Jul-01 Apr-03 Jan-05 Oct-06 Jul-08 Apr-10 Jan-12 Oct-13

Net other investment, 4q sum, % GDPNet portfolio investmentNet direct investmentTotal financial account

-20%

-10%

0%

10%

20%

30%

40%

Oct-99 May-01 Dec-02 Jul-04 Feb-06 Sep-07 Apr-09 Nov-10 Jun-12 Jan-14

Swiss basic balance, narrow, 4q sum, % GDPSwitzerland basic balance, broadSwitzerland basic balance, broad, incl other investment

Source: Deutsche Bank, SNB Source: Deutsche Bank, SNB

Safe haven inflows

Safe haven inflows reversing

27 January 2015



payments data should confirm or reject this one way or the other. Finally, fiduciary deposits related to Switzerlands tax haven status and are in theory the least price sensitive of all foreign inflows, have collapsed from pre-crisis peaks, likely related to the ongoing international pressure on Swiss banking secrecy.

If safe haven inflows have not played an important role in CHF strength recently, what has? The main explanation is that FDI and portfolio outflows, historically offsetting the current account surplus, have been exceptionally weak. By cumulating these flows over the last ten years, this phenomenon is brought into stark relief. Net equity and debt outflows simply stopped in 2008 and in the case of the former, actually began to reverse.

Net flows measure the purchases and sales of both foreigners and domestics, so it is worth breaking down the number to see which gross components are responsible. It is clear that it has been the lack of domestic demand for foreign assets rather than foreign demand for Swiss ones that has caused the lack of Swiss financial outflows. Swiss residents purchases of foreign deposits and foreign debt instruments are CHF 400bn and 250bn below pre-crisis trends respectively.

In effect, since 2012 the SNB have been holding the floor not against foreign speculative or safe-haven inflows, but the countrys own residents. At a less conceptual level, a Swiss corporate that previously recycled its EUR or JPY export earnings by buying EUR fixed income has simply been transferring them into CHF deposits instead.

Understanding this dynamic has some important implications. For one, it helps to explain the SNBs reluctance to commit further to negative rates. Swiss excess liquidity was held by domestics rather than foreigners. Imposing a tax on domestic savings is politically more difficult than penalizing foreign speculators. Additionally, by imposing negative rates on excess cash in a closed monetary system where domestics had been reluctant to invest abroad, the SNB were probably also concerned that this would exacerbate existing financial imbalances. Domestic savers would pass the hot potato of cash round the domestic banking sector, attempting to escape negative rates by shifting funds into bonds, equities and real estate.

Cumulative other investment flows are down since 2012 Even fiduciary deposits have decreased since 2013

-100

0

100

200

300

400

500

Jan-00 Jul-02 Jan-05 Jul-07 Jan-10 Jul-12

Switzerland, cumulative flows, other investment, bns CHF

0

100

200

300

400

500

600

700

800

900

Mar-99 Jul-01 Nov-03 Mar-06 Jul-08 Nov-10 Mar-13

Ficudiary deposits in Swiss banks, CHF bnsUSDEUROther currencies


Crisis

Post-crisis

27 January 2015



For the franc, the fact that pressure has been generated by a lack of capital outflows rather than speculative inflows explains the mystery as to who was buying Swiss assets with exceptionally low yields and relative calm in the global environment. The answer: nobody.

Looking ahead, the key question is if and when domestics begin to resume purchases of foreign assets. The most likely explanation behind the lack of foreign purchases is simply that the Swiss remain extremely risk averse about Europe. Changes in Swiss holdings of foreign debt instruments since the financial crisis show significant divestments of Eurozone fixed income holdings and moderate additions to holdings in the US, Australia and certain EM economies. Another explanation is that while nominal Swiss yields have been very low, Swiss real rates have in fact remained quite high due to very low inflation in Switzerland. Indeed, Swiss real rates were higher than those of the Eurozone until the SNB decision.

Swiss bond and equity outflows have stagnated and even reversed since 2008

-400

-350

-300

-250

-200

-150

-100

-50

0

50

Jan-00 Jul-02 Jan-05 Jul-07 Jan-10 Jul-12

Switzerland, cumulative flows, debt investment, bns CHF

-120

-100

-80

-60

-40

-20

0

Jan-00 Mar-02 May-04 Jul-06 Sep-08 Nov-10 Jan-13

Switzerland, cumulative flows, equity investment, bns CHF


Since 2008, Swiss other investment outflows have decelerated at greater rate than foreign inflows

The Swiss have also not been buying foreign assets

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14

Swiss acquisition foreign assets, other investment, cumulative, % GDPForeign acquisition Swiss assets, other investment

0

0.2

0.4

0.6

0.8

1

1.2

1.4

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14

Swiss acquisitions foreign assets, debt, cumulative, % GDPForeign acquisitions Swiss assets, debt


400bn below trend

250bn below trend

27 January 2015



The dramatic CHF appreciation should have a positive impact on outflows. First, yields on Swiss fixed income securities have traded to record lows across the curve. The move lower in short end rates was exacerbated by the unwind of Swiss funding positions while an entrenching of deflation expectations has weighed on the long end the 10 year rate now negative, below even that of Japans. Yields at these levels should ultimately result in Swiss outflows, at least from institutional investors struggling to meet liabilities.

Second, the 18% appreciation in the franc has served to make foreign assets cheaper for Swiss investors in CHF terms. It should limit the desire for investors to engage in FX hedged transactions. For corporates, the extreme levels in CHF forward rates should make hedging CHF strength less attractive.

It is worth noting that there was already evidence of an improvement in outflows before the SNB decision. While portfolio outflows remain some way below pre-crisis highs, Swiss purchases of combined debt and equity instruments reached post-crisis highs last quarter. If there was already a resurgence in Swiss outflows, this months decision should only encourage

Domestics hold almost all excess liquidity in the Swiss

banking system

The value of European bond holdings declined during the

European sovereign crisis

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

SNB sight deposits

Domestic savings and

deposits

Domestic interbank liabilities

Foreign savings and

deposits

Foreign interbank liabilities

Changes, bns CHF, September 2011-present

-15,000

-10,000

-5,000

-

5,000

10,000

Off

shor

e

Ger

man

y

Oth

er E

urop

e

Spa

in

Gre

ece

UK

Sin

gapo

re

Mex

ico

Kore

a

Aus

tral

ia US

Changes in value of foreign bond holdings, CHF bns, 2009-2012, adjusted for currency valuation impact


Swiss assets now most expensive in the world Some evidence that portfolio outflows are picking up

NZDAUD

GBPUSD

CAD

EUR

CHF

NOKSEK

JPY

0

2

4

6

8

10

12

0 2 4 6 8 10 12

Rank of expensiveness of bonds and equities

-60

-40

-20

0

20

40

60

80

100

Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13

Swiss foreign equity purchases

Swiss foreign debt purchases, 4q sum, CHF, bns

Source: Deutsche Bank, Bloomberg Finance LP Source: Deutsche Bank, SNB

Asset valuation ranking (higher is more expensive, x axis equities, y axis bonds)

27 January 2015



this trend, with a negative impact on the franc.

Appreciation will hit the current account The sudden appreciation of the franc should hurt Switzerlands current account surplus through the trade balance. The one-off appreciation will make imports cheaper and exports more expensive. Indeed, the negative impact of the SNB decision on Switzerlands export sector has already been highlighted by several companies. That said, the adverse impact is mitigated by two factors.

First, Switzerlands current account has proved comparatively insensitive to exchange rate shocks in the past. One reason is that investment income and personal and social transfers comprise a large share and are not directly affected by exchange rate shocks, though they are subject to valuation effects. The Swiss trade balance thus accounts for a relatively small share of the overall current account.

Second, while the trade balance has moved roughly in line with the terms of trade over the previous two decades, it has been largely unresponsive to short-

to medium-term fluctuations. On the import side, recent studies show that the

Trade balance relatively small component of Swiss current account

-80

-60

-40

-20

0

20

40

60

80

2000 2002 2004 2006 2008 2010 2012

CHF bn Goods Services Primary income Secondary income Capital transfers

Source: Deutsche Bank, SNB

Loose relationship between trade balance and terms of

trade in short- to medium-run

No impact of strong CHF on trade balance in recent

years

-5%

0%

5%

10%

15%

20%-20

-15

-10

-5

0

51996 1998 1999 2000 2002 2003 2004 2006 2007 2008 2010 2011 2012 2014

Terms of Trade, 12mma (inverted)

Total trade balance as % of GDP, 1Y rolling sum

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%70

80

90

100

110

120

130

140

1988 1990 1993 1995 1997 1999 2002 2004 2006 2008 2011 2013

CHF REERTotal trade balance as % of GDP, 1Y rolling sum (inverted)


27 January 2015



exchange rate pass-through to import prices is far from complete and amounts to only about 50% in cumulative terms.3 An appreciation of 10%, therefore, would lower import prices by only 5%. This is likely explained by price discrimination: exporters to Switzerland are likely to adjust Swiss-specific markups in order to benefit from rising Swiss purchasing power.4

On the export side, the transmission from the exchange rate to export prices is difficult to gauge and direct export elasticities are more informative. The most recent academic research on Switzerland indicates that a 20% appreciation of the Swiss exchange rate against the rest of the world should reduce exports of goods and services by 10-20%.5 An export elasticity of unity is clearly the upper bound, with 0.5 again being the most realistic estimate. The elasticity is relatively low in international comparison. One reason is that Swiss exports are heavily services-centered. Services typically have a lower export elasticity than goods. A second reason is the sophistication of Swiss goods exports, which are increasingly geared towards the luxury consumer goods segment. Hence, exports have been more sensitive to income changes in importing countries. There is also probably some truth in the SNBs claim that the Swiss export industry is today better prepared to compete internationally despite a strong CHF, defending export volumes and markups through lower costs.

One sector likely to be hit hard by the appreciation is tourism. It is not a clich that foreign tourists are highly sensitive to the exchange rate. Nights spent by European visitors exhibit a clear relationship with the exchange rate. However, with tourism accounting for only 10% of the countrys services exports, the overall impact on the current account is likely to be fairly limited.

Yet even taking into account the low elasticity of Swiss export and import demand, the sheer size of appreciation will contribute negatively to Switzerlands bilateral surplus. Moreover, the sudden appreciation of the franc may have a more powerful effect on bilateral trade balances. It is worth noting that the largest trade surplus Switzerland generates is with Japan. As a

3 See Stulz, 2007, Exchange rate pass-through in Switzerland: Evidence from vector autoregressions, SNB Working Paper. This is in line with average international pass-through rates of 50-70%, see for instance Campa and Goldberg, 2005, Exchange rate pass-through into import prices, Review of Economics and Statistics. 4 On the concept of pricing-to-market in international trade, see Obstfeld and Rogoff, 1995,Exchange rate dynamics redux, Journal of Political Economy. 5 See Thorbecke and Kato, 2014, Export Sophistication and Exchange Rate Elasticities: The Case of Switzerland, RIETI Discussion Paper, http://www.rieti.go.jp/jp/publications/dp/14e031.pdf, and Auer and Saure, 2012, CHE strength and Swiss export performance evidence and outlook from a disaggregated analysis, Applied Economics Letters.

Swiss exports concentrated in luxury consumer goods Tourism likely to be negatively impacted by appreciation

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1988 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2012

Raw materials and semi-manufactures Capital goods Consumer goods

85

90

95

100

105

11017,000

18,000

19,000

20,000

21,000

22,000

23,000

24,000

25,000

1997 1998 2000 2001 2003 2004 2006 2008 2009 2011 2012 2014

1999 = 1001,000 nights Nights spent by foreign tourists, 1Y rolling sumCHF REER, 12mma


27 January 2015



consequence of expansionary monetary policy, the JPY had already depreciated substantially versus the franc before the SNB decision. After this months move CHF/JPY now stands 66% more expensive than in Q3 2012. On the import side, Switzerlands largest net deficit is with the Eurozone. A weakening euro should ensure that Swiss purchasing power continues to rise with the single currency area, worsening the deficit.

SNB likely to want to minimize the damage to deflation By taking the decision to abandon the EUR/CHF floor, the SNB have become the first modern central bank to prioritize financial stability above price stability. The corollary is that Switzerland now faces the prospect of outright deflation.

The effect of this months currency appreciation on Swiss inflation will be compounded by several factors. First, the base is extremely low with CPI having averaged -0.2% over the last 12 months and with the most recent CPI print for December already showing a sharp acceleration in deflation to -0.3%. Second, Swiss inflation will also be hit by falling oil prices. Switzerland is a large energy importer, and crude prices have demonstrated a strong relationship with Swiss inflation in the past. Third, FX/CPI elasticities are high relative to other developed economies. The IMF estimates the FX/CPI pass- through coefficient at 0.08 in Switzerland versus 0.05 in Germany, while a simple regression exercise using CHF and CPI would suggest that for every

Switzerlands largest surplus is with Japan, but well diversified

By contrast, large import-dependency on Eurozone

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

Japan Hong Kong UK Canada Russia UEA Australia

CHFmn

-25,000

-20,000

-15,000

-10,000

-5,000

-EMU China

Czech Republic Nigeria Vietnam Hungary

CHFmn


Switzerland has one of the highest FX-CPI pass-throughs

in G10

Swiss CPI is highly sensitive to oil prices

-0.02-0.01

00.010.020.030.040.050.060.070.080.09

Fran

ce

Can

ada

Spai

n

Nor

way

Swed

en

Aus

tral

ia

Italy

Ger

man

y

Irela

nd

Switz

erla

nd

IMF FX-CPI pass-through coefficients

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

3

-80

-60

-40

-20

0

20

40

60

80

Dec-96 Dec-00 Dec-04 Dec-08 Dec-12

6 month change in Brent Crude, lagged 6m

Swiss CPI, 6m average

Source: Deutsche Bank, IMF Source: Deutsche Bank, Bloomberg Finance LP

27 January 2015



10% rise in CHF TWI, headline inflation should fall by one percent.6 Other estimates of the pass-through from FX to inflation vary but all are consistent with the view that, together with the fall in oil prices, Swiss CPI falls well below its previous trough of -1.2% yoy in 2009.7

We would expect significant downward revisions to the SNBs price projections at the next monetary policy report in March. It is important to note that even if the SNB were to revise down their 2 year inflation forecast to negative this does not technically represent a breach of their price stability mandate, which is defined as inflation of less than 2% per annum. However, the central bank explicitly acknowledges that the mandate is non-asymmetric, making clear that both inflation and deflation hamper economic development.

6 Choudhri and Hakura, 2001, Exchange Rate Pass-Through to Domestic Prices: Does the Inflationary Environment Matter?, IMF Working Paper. 7 The OECD have estimated the impact of a 10% currency appreciation at a much higher 2%, although the authors note that the number would be less for a depreciation given the stickier nature of prices to the downside, see Dalsgaard et al, 2001, Standard Shocks in the OECD Interlink Model, OECD Working Paper. The SNB estimate the maximum cumulative pass-through at 0.12 after 3 month of the shock, see Stulz, 2007, Exchnage Rate pass-Through in Switzerland: Evidence from vector autoregressions.

Swiss retail sales have been collapsing Swiss households among most indebted in world

-60

-50

-40

-30

-20

-10

0

10

20

-2

-1

0

1

2

3

4

5

6

Jan-03 Nov-04 Sep-06 Jul-08 May-10 Mar-12 Jan-14

Switzerland retail sales, yoy, 3m average

Switzerland consumer confidence, rhs

0

50

100

150

200

250

300

Italy

Ger

man

y

Fran

ce US

Japa

n

UK

Sw

eden

Aus

tral

ia

Sw

itzer

land

Nor

way

Net

herla

nds

Household debt as % Gross Domestic Income

Source: Deutsche Bank, Macrobond Source: Deutsche Bank, Bloomberg Finance LP

Only small share of deposits subject to -0.75% rate implying a higher blended average interest rate

0

50

100

150

200

250

300

350

Required reserves Exempt amount Deposits at -0.75% Total sight deposits

CHF bn

multiplied by 20

-0.10%

0.00%

0.10%

0.20%

0.30%

0.40%

0.50%

0.60%

0.70%

0.80%

-50

0

50

100

150

200

250

300

350

400

Dec-00 Jun-03 Dec-05 Jun-08 Dec-10 Jun-13

Excess liquidity charged at -75bpSNB sight deposits, bn CHFBlended cost of funds for banks, rhs


27 January 2015



While the Swiss economy has withstood periods of low inflation or deflation in the past, the effect of heavy deflation comes at a worrying time. The external growth outlook, particularly among key export partners in Asia and other emerging markets, is fragile. At home, domestic consumption has been weak recently, illustrated by a steep decline in retail sales. While there is not yet evidence of consumers delaying purchases, were deflation expectations to become entrenched, this could materialize. The likelihood of such a scenario has been raised by both the probable size of a deflationary shock (i.e. below the crisis trough in inflation) as well as the loss of credibility of the SNB in pursuing its price stability mandate. Indeed, this is precisely what the market has begun to price, with 10 year Swiss yields falling below negative.

It is worth remembering that Swiss households are among the most indebted in the world. A key concern for the SNB in recent years has been the size of leverage in the real estate market. With such a large nominal debt stock, a prolonged period of deflation could carry significant financial stability risks by increasing the nominal debt stock and household repayments. This is not likely to be offset by higher wages, which have been stagnant since 2013. Swiss households could offset this using their considerable savings, but this would hardly be a positive for consumption.

For these reasons we believe that the SNB will be keen to minimize the possibility of deflationary tail risks by resisting further large-scale appreciation in the franc. While the policy of targeting an absolute level in the currency has clearly been abandoned, the central bank still possesses monetary policy tools.

Most obviously, the SNB can continue to intervene in currency markets. Indeed, sight deposit data released this week suggests that interventions have continued after the abandoning of the EUR/CHF floor. The risk of such a strategy is that the SNB take on more balance sheet risk, as well as further expanding liquidity in the domestic banking system. In theory, the SNBs foreign exchange reserves as a percentage of GDP have been reduced by around 20% through the appreciation of the franc, potentially allowing them more leeway to expand. However, franc liquidity in the domestic banking system has not been reduced.

Why not go really negative? Another option for the SNB is to cut rates again. The interest rate on excess reserves stands at -0.75bp following this months decision. However, this rate

CHF rates now well below those of EUR even if ECB QE may not be fully priced

-0.5

0

0.5

1

1.5

2

2.5

Dec-07 Dec-09 Dec-11 Dec-13

1m EONIA - 1m TOIS Swap12m


27 January 2015



is only applied to reserves 20 times above the required reserves of domestic banks and above a specific cap for foreign banks, meaning only a small amount of excess liquidity is captured. The SNB could choose to lower the threshold and cap over which excess reserves are charged, or cut the rate itself.

This distinction is meaningful for the currency outlook. Currently, the SNBs negative rate policy has only altered the marginal cost of funding for banks i.e. the cost of creating new reserves through net lending.

What matters more is the average cost of funding, i.e. the rate applying to the stock of excess liquidity as this is what banks must ultimately pass onto depositors. Because most excess liquidity is not charged under the current regime, depositors have not felt the effect of negative rates. This goes some way in explaining that while money market rates have moved sharply in favour of the euro against the franc since the decision, CHF weakness has not followed. Negative rates in Switzerland are negative in name only.

The reluctance of the SNB to apply negative rates to a larger amount of excess liquidity may be explained by their unwillingness to penalize domestic savers for, as we argue above, most of the excess liquidity has been generated by Swiss, not foreign, deposits. There may also be concern that by charging negative rates on excess liquidity in a closed monetary system, the SNB would exacerbate asset price distortions as savers desperately seek alternatives (bonds, stocks, real estate) to being charged for deposits. Interestingly, while the SNB have been reluctant to pursue this path, this is precisely the policy the ECB has adopted in its announcement of QE last week.

If the SNB continue to prove reluctant to incentivize depositors to move out of francs by lowering the threshold on excess reserves, they may find their ability to influence the franc and monetary conditions in Switzerland limited to currency intervention. Mechanically, of course, further intervention would lower the average cost of funding by increasing the amount of liquidity subject to negative rates. However, the central bank would be faced with precisely the same problem as prior to abandoning the floor an open ended commitment to expand the balance sheet.

Because of this, it is hard not to see this months decision as a tactical policy mistake. The central banks policy options and the risks associated with them are exactly the same as before abandoning the floor, but hugely damaged credibility in the eyes of the market and the additional costs of a near 20% write-down in value of its foreign exchange portfolio, notwithstanding the effect of the depreciation in terms of price stability and Swiss competitiveness. Of course, it may simply be that the SNB have given up on policy as a tool with which to influence monetary conditions altogether.

It is also worrying that the significant move lower in Swiss rates, partly driven by unwinds of CHF funding positions, implies that the market is pricing further action by the SNB. If such action does not materialize, Swiss rates could move back up again as funding conditions normalize.

We do not think that the public QE announcement from the ECB is likely to see a big move lower in EUR/CHF, however. ECB QE could result in portfolio rebalancing away from euro fixed income assets and into Swiss ones, but this is unconvincing. Negatively yielding Swiss portfolio assets are not natural alternatives for European investors escaping from financial repression. As we have noted above, it has not been European purchases of Swiss assets generating pressure on the floor, but the failure of Swiss residents to purchase foreign assets. A greater concern would be an increase in global or Eurozone

27 January 2015



risk premia (i.e. because of the Greek election results) could result in more safe-haven inflows into Switzerland and appreciation pressure on the franc.

Updated forecasts Weighing up the above, we believe that valuation effects and the eventual resumption of Swiss outflows should ultimately trump risks of a return of safe-haven inflows and SNB policy paralysis. For this reason, our updated CHF forecasts see the currency gradually weakening against both the dollar and the euro on a multi-year basis. In the short term, however, the market will take some time to recover from its recent trauma and it may be some time before residual CHF short positioning is washed out. Until an effective price-discovery process resumes, the best way to express a bearish CHF view may be to buy long dated CHF puts against EUR or USD.

Q2 2015 Q4 2015 2016 2017 2018 2019

EUR/CHF

1.05 1.08 1.15 1.20 1.25 1.25

USD/CHF

0.91 0.98 1.15 1.33 1.39 1.39

27 January 2015



Spillover effects

The spillover effects of this months SNB decision can be split into implications for financial markets, trade and policy.

Other asset classes Because the SNB are no longer committed to buying unlimited amounts of euros to protect the 1.20 floor, one consequence of the SNBs decision may be to reduce SNB intervention. Intervention had begun to pick up again in recent months with reserves rising to CHF 470bn by Q4 last year from their level of CHF 450bn between Q4 2012 and Q1-2014. Sight deposit data, a proxy for SNB buying, suggests that intervention accelerated sharply in recent weeks. Sight deposits rose from CHF 329bn to CHF 340bn in the week of the decision, a sharp increase. Less SNB intervention is a moderate positive for the euro, in that it implies less EUR/cross selling from the central bank. It is worth noting, however, that the decision does not mean the SNB will stop intervening altogether (see above). Moreover, one consequence of the decision will be that investors rotate out of USD/CHF longs to EUR/USD shorts. Taken together, these effects on the euro should broadly cancel one another out. As a result, this does not change our bearish (1.10 year end) EUR/USD forecast.

On the rates side, lower Swiss yields (the 10 year yield is now negative) as well as the positive valuation effect, should encourage Swiss outflows into fixed income. This will likely benefit core European fixed income, gilts and US Treasuries the most.

The appreciation will hurt Swiss debtors not foreign ones Much attention has been paid to the valuation losses suffered by foreign debtors to Switzerland, whether speculators funding carry trades or Eastern Europeans servicing Swiss mortgages. But this misses one important fact. While the world has considerable net liabilities to Switzerland, it does not owe it Swiss francs. Swiss net claims on the world are denominated in foreign currencies; in CHF, Switzerland is a net borrower. In aggregate, therefore, the appreciation of CHF harms Swiss debtors, rather than foreign ones.

Also contrary to popular belief, the majority of Swiss CHF-denominated assets abroad fall under the portfolio investment category, rather than bank credit. Foreign investors have traditionally liked tapping into the Swiss capital markets by issuing bonds or money market instruments in local currency. These flows have abated in recent years, with most Swiss portfolio investment attributable

The world owes Switzerland much, but not Swiss francs

-2,000

-1,500

-1,000

-500

0

500

1,000

CHF USD EUR Other currencies

NIIP, CHF bnFDI Portfolio investment Derivatives Other investment Reserves

Source: Deutsche Bank, SNB Note: NIIP data as of Q3 2014

27 January 2015



to currencies other than CHF and EUR.

Hence, virtually all of Switzerlands accumulation of foreign assets in recent years has been in foreign currencies. The fall in the share of CHF-denominated assets is not only the result of slowing capital market transactions in local currency, but also of the appreciation of CHF in the past five years or so. At the same time, Switzerland has borrowed primarily in Swiss francs, in the form of both portfolio inflows and foreign direct investment. This asymmetry in Switzerlands CHF-specific financial account remains intact even when netting out the accumulation of official foreign reserves.

Fixed income investors exposed to Switzerland would have actually profited not only from the positive valuation effect but also from positive market valuation effects as the Swiss bond market rallied in the aftermaths of the SNBs decision. In the equities space, foreign investors registered heavy marked-to-market losses. Yet with most Swiss equity issued in CHF, investors that were not forced to realize losses will benefit from the positive FX valuation effects.

Financial centers more exposed to Swiss lending than CEE BIS data show that Swiss lending is highly intermediated through the UK and offshore financial centres. Normalizing liabilities to Swiss banks by GDP indicates that the UK owes Switzerland 10% of GDP. This ratio is as high as 7000% for the Cayman Islands. This is consistent with the negligible claims of Swiss banks on CEE economies relative to their size. CHF denominated mortgages in these countries tend to be intermediated by third-country lenders linked to Switzerland either through equity or funding. These figures do not therefore represent underlying domestic liabilities to Switzerland on an ultimate risk basis, and therefore distort which countries are ultimately exposed to Swiss lending.

Exposure to CHF as a global funding currency limited The fact that the world owes no Swiss francs to Switzerland directly does not necessarily mean that global CHF-denominated liabilities are negligible. Households in CEE economies in particular service considerable mortgage debt denominated in CHF but not ultimately underwritten by Swiss lenders. Yet even to the extent that CHF is detached from Swiss lending as a global funding currency, we think the impact of its appreciation is limited. First, only 1.5% of outstanding global debt is denominated in CHF.

Swiss accumulation of CHF-denominated foreign claims

has been negative in recent years

while most borrowing is in CHF

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

1999 2001 2003 2005 2007 2009 2011 2013

Swiss assets, CHF bn

CHF USD EUR Other currencies

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

1999 2001 2003 2005 2007 2009 2011 2013

USD EUR Other currencies CHF


27 January 2015



Second, in economies with high ratios of CHF loans to GDP, most notably Hungary and Poland, the currency exposure has or will be managed with relative ease. As of Q3 2014, Polish and Hungarian households were estimated to be servicing CHF-denominated debt of 8% and 9% of GDP respectively. In Hungary, households were already forced to convert mortgages to local currency in December, at a fixed exchange rate as of 7 November. Hence, much of Hungarys CHF loan exposure has already been eliminated. In Poland, exposure through mortgages remains high, but default rates have been negligible as CHF appreciated in recent years. Key to this is that Polish banks tend to re-denominate mortgages in local currency in cases of high default risk. In other words, the cost of CHF appreciation will be borne by the households with the lowest default risk.

Financial markets are the biggest losers The data above underscores the reality that the largest loser from the Swiss appreciation, aside from the Swiss themselves, is the financial industry. Banks will face write downs in asset quality arising from loans and investment denominated in CHF. There may be contractual difficulties arising from settling claims in instruments that had been predicated on the inviolability of the 1.20 EUR/CHF floor. Corporates that had hedged exports or earnings in anticipation of franc weakness face the unwelcome prospect of buying them back. For

Swiss banks have large claims on offshore entities Debt-to-GDP ratios point to financial intermediation role

of offshore centres

0

100

200

300

400

500

600

700

US

Eur

o ar

ea UK

Cay

man

W

est I

ndie

s

Hon

g K

ong

Sin

gapo

re

Japa

n

Can

ada

Chi

na

Aus

tralia

Pan

ama

UA

E

Indi

a

Kor

ea

Mex

ico

Bra

zil

Turk

ey

Rus

sia

Ber

mud

a

New

Zea

land

Pol

and

Cze

ch R

epub

lic

Hun

gary

Swiss bank claims, USD bn

0%

20%

40%

60%

80%

100%

120%

140%

Ber

mud

a

Pan

ama

Hon

g K

ong

UK

Sin

gapo

re US

Eur

o ar

ea

UA

E

New

Zea

land

Can

ada

Aus

tralia

Turk

ey

Kor

ea

Mex

ico

Japa

n

Indi

a

Bra

zil

Rus

sia

Pol

and

Hun

gary

Cze

ch R

epub

lic

Chi

na

Swiss claims / GDP

Source: Deutsche Bank, BIS

Source: Deutsche Bank, BIS Note: Cayman Islands not shown: > 7,000%

CHF-denominated assets mostly in portfolio investments Recent net portfolio investments primarily in USD and

other currencies

-1200

-1000

-800

-600

-400

-200

0

200

400

Direct investment Portfolio investment Derivatives Other investment

CHF bn Assets denominated in CHF Liabilities denominated in CHF

-20,000

-

20,000

40,000

60,000

80,000

100,000

120,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

CHF bn, cumulative

CHF EUR USD Other currencies


27 January 2015



their part, investors and dealers face losses from covering CHF funding positions. The scale of the dislocation in the foreign exchange market has been evident in the behavior of short-dated CHF FX forwards in which implied yields have been pushed to several percentage points below zero.

The huge intra-day move will serve as a massive VaR shock to the market, in a period in which investors were sensitive to P&L swings at the start of the year. The cutting back of risk limits will itself reduce the ability of investors to make lost money back. The shock may also reignite the debate about the suitability of proprietary and regulatory risk models. This would come at a particularly critical time as in several instances regulators have still to finalize requirements based on capital requirements for the trading book and which models are suitable for use in calculating capital requirements.8

European exporters to gain most from changing terms of trade To the extent that the improvement in the Swiss terms of trade will affect its trade balance, the marginal demand for imports will largely benefit Switzerlands European neighbours. Germany alone accounts for almost 30%

8 See the current debate on replacing the Current Exposure Method for calculation of counterparty credit risk under Basel III, for example

Only 1.5% of outstanding global debt denominated in CHF

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

CHF USD EUR JPY GBP Others

USD bn Fixed rate Floating rate Other

Source: Deutsche Bank, BIS

Almost one third of Swiss imports come from Germany Economies with greatest export dependency on

Switzerland mostly European neighbours

0%

5%

10%

15%

20%

25%

30%

35%

Ger

man

y

Oth

er E

urop

e

Italy

Fran

ce

Oth

er A

sia

Chi

na

Nor

th A

mer

ica

Aus

tria

Irela

nd

Net

herla

nds

ME

A

Spa

in

Bel

gium

Latin

Am

eric

a

Share of Swiss imports in 2013

0%

1%

1%

2%

2%

3%

3%

4%

Irela

nd

Aus

tria

Ger

man

y

Cze

ch R

epub

lic

Slo

vaki

a

Slo

vaki

a

Italy

Bel

gium

Net

herla

nds

Fran

ce

Hon

g K

ong

Por

tuga

l

Vie

tnam

Spa

in

Sin

gapo

re

Pol

and

Rom

ania

Den

mar

k

UK

Finl

and

Exports to Switzerland / GDP

Source: Deutsche Bank Source: Deutsche Bank

27 January 2015



of Swiss goods imports, followed by Italy and France. These immediate neighbours are also likely to benefit in the services sector, with tourism being the obvious example. In terms of national income, small European economies such as Ireland and Austria exhibit the greatest dependency on exports to Switzerland. Assuming constant Swiss import elasticities, Europe thus also stands to gain the most from any Swiss import substitution.

Policy implications The SNBs decision has implications for central bank policy more generally. As the first central bank to prioritize financial stability over price stability, they have punctured the belief that the challenges arising from extraordinary monetary policy are fundamentally technical rather than existential in nature.

The move may have undermined the credibility of other fixed or semi-fixed exchange rate regimes. While exchange rate pegs have been brought down in the past, this is the first time that a central bank has been defeated on its theoretically unlimited ability to defend the weakness of its currency by printing money. Previously, regimes have been shattered after central banks ran up against the intrinsic policy constraint of a finite amount of foreign reserves. Central banks in similar positions to the SNB, such as the Danish Nationalbank, Czech National Bank and the Hong Kong Monetary Authority may find that speculators seek to test their commitment, with the result that these arrangements become more expensive to maintain. Such an outcome may already be afoot after the Danish Nationalbank chose to cut interest on certificates of deposit back to -0.2% this week to discourage foreign inflows.

For central banks contemplating the introduction of currency floors, the end of the SNBs experiment may provide food for thought. For example, the Riksbank have noted that one potential option to ward off deflationary risks is the introduction of a EUR/SEK currency floor. The move also has important implications for the ECB too. A public QE announcement by the ECB accompanying negative rates is conceptually exactly the same framework the SNB shied away from, involving charges on excess liquidity in a closed system. Of course, excess liquidity is considerably lower in aggregate in the Eurozone than in Switzerland. However, for individual countries where the banking system is awash with liquidity, such as Germanys, the risks are broadly comparable.

27 January 2015



Appendix 1

Important Disclosures Additional information available upon request For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr Analyst Certification

The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Oliver Harvey/Robin Winkler

27 January 2015



(a) Regulatory Disclosures (b) 1. Important Additional Conflict Disclosures

Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.

(c) 2. Short-Term Trade Ideas Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the SOLAR link at http://gm.db.com.

(d) 3. Country-Specific Disclosures Australia and New Zealand: This research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act and New Zealand Financial Advisors Act respectively. Brazil: The views expressed above accurately reflect personal views of the authors about the subject company(ies) and its(their) securities, including in relation to Deutsche Bank. The compensation of the equity research analyst(s) is indirectly affected by revenues deriving from the business and financial transactions of Deutsche Bank. In cases where at least one Brazil based analyst (identified by a phone number starting with +55 country code) has taken part in the preparation of this research report, the Brazil based analyst whose name appears first assumes primary responsibility for its content from a Brazilian regulatory perspective and for its compliance with CVM Instruction # 483. EU countries: Disclosures relating to our obligations under MiFiD can be found at http://www.globalmarkets.db.com/riskdisclosures. Japan: Disclosures under the Financial Instruments and Exchange Law: Company name - Deutsche Securities Inc. Registration number - Registered as a financial instruments dealer by the Head of the Kanto Local Finance Bureau (Kinsho) No. 117. Member of associations: JSDA, Type II Financial Instruments Firms Association, The Financial Futures Association of Japan, Japan Investment Advisers Association. This report is not meant to solicit the purchase of specific financial instruments or related services. We may charge commissions and fees for certain categories of investment advice, products and services. Recommended investment strategies, products and services carry the risk of losses to principal and other losses as a result of changes in market and/or economic trends, and/or fluctuations in market value. Before deciding on the purchase of financial products and/or services, customers should carefully read the relevant disclosures, prospectuses and other documentation. "Moody's", "Standard & Poor's", and "Fitch" mentioned in this report are not registered credit rating agencies in Japan unless "Japan" or "Nippon" is specifically designated in the name of the entity. Malaysia: Deutsche Bank AG and/or its affiliate(s) may maintain positions in the securities referred to herein and may from time to time offer those securities for purchase or may have an interest to purchase such securities. Deutsche Bank may engage in transactions in a manner inconsistent with the views discussed herein. Qatar: Deutsche Bank AG in the Qatar Financial Centre (registered no. 00032) is regulated by the Qatar Financial Centre Regulatory Authority. Deutsche Bank AG - QFC Branch may only undertake the financial services activities that fall within the scope of its existing QFCRA license. Principal place of business in the QFC: Qatar Financial Centre, Tower, West Bay, Level 5, PO Box 14928, Doha, Qatar. This information has been distributed by Deutsche Bank AG. Related financial products or services are only available to Business Customers, as defined by the Qatar Financial Centre Regulatory Authority. Russia: This information, interpretation and opinions submitted herein are not in the context of, and do not constitute, any appraisal or evaluation activity requiring a license in the Russian Federation. Kingdom of Saudi Arabia: Deutsche Securities Saudi Arabia LLC Company, (registered no. 07073-37) is regulated by the Capital Market Authority. Deutsche Securities Saudi Arabia may only undertake the financial services activities that fall within the scope of its existing CMA license. Principal place of business in Saudi Arabia: King Fahad Road, Al Olaya District, P.O. Box 301809, Faisaliah Tower - 17th Floor, 11372 Riyadh, Saudi Arabia. United Arab Emirates: Deutsche Bank AG in the Dubai International Financial Centre (registered no. 00045) is regulated by the Dubai Financial Services Authority. Deutsche Bank AG - DIFC Branch may only undertake the financial services activities that fall within the scope of its existing DFSA license. Principal place of business in the DIFC: Dubai International Financial Centre, The Gate Village, Building 5, PO Box 504902, Dubai, U.A.E. This information has been distributed by Deutsche Bank AG. Related financial products or services are only available to Professional Clients, as defined by the Dubai Financial Services Authority.

(e) Risks to Fixed Income Positions Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise to pay fixed or variable interest rates. For an investor that is long fixed rate instruments (thus receiving these cash flows), increases in interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a

27 January 2015



loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse macroeconomic shocks to receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation (including changes in assets holding limits for different types of investors), changes in tax policies, currency convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed income instruments to macroeconomic shocks may be mitigated by indexing the contracted cash flows to inflation, to FX depreciation, or to specified interest rates - these are common in emerging markets. It is important to note that the index fixings may -- by construction -- lag or mis-measure the actual move in the underlying variables they are intended to track. The choice of the proper fixing (or metric) is particularly important in swaps markets, where floating coupon rates (i.e., coupons indexed to a typically short-dated interest rate reference index) are exchanged for fixed coupons. It is also important to acknowledge that funding in a currency that differs from the currency in which the coupons to be received are denominated carries FX risk. Naturally, options on swaps (swaptions) also bear the risks typical to options in addition to the risks related to rates movements.

David Folkerts-Landau

Group Chief Economist Member of the Group Executive Committee

Raj Hindocha

Global Chief Operating Officer Research

Marcel Cassard Global Head

FICC Research & Global Macro Economics

Richard Smith and Steve Pollard Co-Global Heads Equity Research

Michael Spencer Regional Head

Asia Pacific Research

Ralf Hoffmann Regional Head

Deutsche Bank Research, Germany

Andreas Neubauer Regional Head

Equity Research, Germany

Steve Pollard Regional Head

Americas Research

International Locations

Deutsche Bank AG Deutsche Bank Place Level 16 Corner of Hunter & Phillip Streets Sydney, NSW 2000 Australia Tel: (61) 2 8258 1234

Deutsche Bank AG Groe Gallusstrae 10-14 60272 Frankfurt am Main Germany Tel: (49) 69 910 00

Deutsche Bank AG Filiale Hongkong International Commerce Centre, 1 Austin Road West,Kowloon, Hong Kong Tel: (852) 2203 8888

Deutsche Securities Inc. 2-11-1 Nagatacho Sanno Park Tower Chiyoda-ku, Tokyo 100-6171 Japan Tel: (81) 3 5156 6770

Deutsche Bank AG London 1 Great Winchester Street London EC2N 2EQ United Kingdom Tel: (44) 20 7545 8000

Deutsche Bank Securities Inc. 60 Wall Street New York, NY 10005 United States of America Tel: (1) 212 250 2500

Global Disclaimer The information and opinions in this report were prepared by Deutsche Bank AG or one of its affiliates (collectively "Deutsche Bank"). The information herein is believed to be reliable and has been obtained from public sources believed to be reliable. Deutsche Bank makes no representation as to the accuracy or completeness of such information.

Deutsche Bank may engage in securities transactions, on a proprietary basis or otherwise, in a manner inconsistent with the view taken in this research report. In addition, others within Deutsche Bank, including strategists and sales staff, may take a view that is inconsistent with that taken in this research report.

Opinions, estimates and projections in this report constitute the current judgement of the author as of the date of this report. They do not necessarily reflect the opinions of Deutsche Bank and are subject to change without notice. Deutsche Bank has no obligation to update, modify or amend this report or to otherwise notify a recipient thereof in the event that any opinion, forecast or estimate set forth herein, changes or subsequently becomes inaccurate. Prices and availability of financial instruments are subject to change without notice. This report is provided for informational purposes only. It is not an offer or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy. Target prices are inherently imprecise and a product of the analyst judgement. The financial instruments discussed in this report may not be suitable for all investors and investors must make their own informed investment decisions. Stock transactions can lead to losses as a result of price fluctuations and other factors. If a financial instrument is denominated in a currency other than an investor's currency, a change in exchange rates may adversely affect the investment. Past performance is not necessarily indicative of future results. Deutsche Bank may with respect to securities covered by this report, sell to or buy from customers on a principal basis, and consider this report in deciding to trade on a proprietary basis. Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies.

Derivative transactions involve numerous risks including, among others, market, counterparty default and illiquidity risk. The appropriateness or otherwise of these products for use by investors is dependent on the investors' own circumstances including their tax position, their regulatory environment and the nature of their other assets and liabilities and as such investors should take expert legal and financial advice before entering into any transaction similar to or inspired by the contents of this publication. Trading in options involves risk and is not suitable for all investors. Prior to buying or selling an option investors must review the "Characteristics and Risks of Standardized Options," at http://www.theocc.com/components/docs/riskstoc.pdf . If you are unable to access the website please contact Deutsche Bank AG at +1 (212) 250-7994, for a copy of this important document.

The risk of loss in futures trading and options, foreign or domestic, can be substantial. As a result of the high degree of leverage obtainable in futures and options trading losses may be incurred that are greater than the amount of funds initially deposited.

Unless governing law provides otherwise, all transactions should be executed through the Deutsche Bank entity in the investor's home jurisdiction. In the U.S. this report is approved and/or distributed by Deutsche Bank Securities Inc., a member of the NYSE, the NASD, NFA and SIPC. In Germany, this report is approved and/or communicated by Deutsche Bank AG, a joint stock corporation with limited liability incorporated in the Federal Republic of Germany with its principal office in Frankfurt am Main. Deutsche Bank AG is authorised under German Banking Law (competent authority: European Central Bank) and is subject to supervision by the European Central Bank and by BaFin, Germanys Federal Financial Supervisory Authority. In the United Kingdom, this report is approved and/or communicated by Deutsche Bank AG acting through its London Branch at Winchester House, 1 Great Winchester Street, London EC2N 2DB. Deutsche Bank AG in the United Kingdom is authorised by the Prudential Regulation Authority and is subject to limited regulation by the Prudential Regulation Authority and Financial Conduct Authority. Details about the extent of our authorisation and regulation by the Prudential Regulation Authority, and regulation by the Financial Conduct Authority are available from us on request. This report is distributed in Hong Kong by Deutsche Bank AG, Hong Kong Branch, in Korea by Deutsche Securities Korea Co. This report is distributed in Singapore by Deutsche Bank AG, Singapore Branch or Deutsche Securities Asia Limited, Singapore Branch (One Raffles Quay #18-00 South Tower Singapore 048583, +65 6423 8001), and recipients in Singapore of this report are to contact Deutsche Bank AG, Singapore Branch or Deutsche Securities Asia Limited, Singapore Branch in respect of any matters arising from, or in connection with, this report. Where this report is issued or promulgated in Singapore to a person who is not an accredited investor, expert investor or institutional investor (as defined in the applicable Singapore laws and regulations), Deutsche Bank AG, Singapore Branch or Deutsche Securities Asia Limited, Singapore Branch accepts legal responsibility to such person for the contents of this report. In Japan this report is approved and/or distributed by Deutsche Securities Inc. The information contained in this report does not constitute the provision of investment advice. In Australia, retail clients should obtain a copy of a Product Disclosure Statement (PDS) relating to any financial product referred to in this report and consider the PDS before making any decision about whether to acquire the product. Deutsche Bank AG Johannesburg is incorporated in the Federal Republic of Germany (Branch Register Number in South Africa: 1998/003298/10). Additional information relative to securities, other financial products or issuers discussed in this report is available upon request. This report may not be reproduced, distributed or published by any person for any purpose without Deutsche Bank's prior written consent. Please cite source when quoting.

Copyright 2015 Deutsche Bank AG

Date post:	06-Jan-2016
Category:	Documents
Upload:	kunalwarwick
View:	227 times
Download:	0 times

DB Swiss Special Report-2

Documents