Is it worth buying Swiss government bonds now?

In last March's blog, we noted that the average swap spread – i.e. the interest rate differential between the swap rates for certain maturities and Confederation bonds with identical maturities – had fallen back to around 50 basis points. By way of comparison, in August 2022 it was between 90 and 100 basis points for various maturity segments. Since the long-term average of the swap spread is around 40 basis points, we concluded at the time that the relative attractiveness of Swiss government bonds remained low.

Meanwhile, the swap spread for various maturities narrowed considerably. Although yields on risk-free Swiss government bonds (or ‘Konis’) have fallen since the beginning of the year, they have only partially offset the sharp decline in swap rates.

The causes were a lower hedging requirement for banks due to fewer long-dated mortgages and brisk issuance activity in foreign bonds since the beginning of the year. Demand for so-called safe haven assets such as Swiss government bonds is not particularly pronounced despite the economic challenges. This was confirmed by the latest auctions, at which investors showed little demand for risk-free bonds. This was not a problem, however, as the Swiss government has low financing requirements. As a result, the swap spreads for all maturities have fallen below the long-term median of 40 basis points.

Is it now time to increase the weighting of Swiss government bonds in CHF bond portfolios again? The situation is not clear-cut.

Focus on short-dated Swiss government bonds

In addition to the development of the swap spread, we also look at the yield spread between Swiss government bonds and mortgage-backed bonds with the same maturity. Historically, the median spread of mortgage-backed bonds over a similarly long-dated Swiss Confederation bond has been 40 basis points for maturities of over five years since 2015. For shorter maturities, the spread is closer to 30 basis points.

The above chart shows that the yield premium of AAA-rated mortgage-backed bonds over a Swiss Confederation bond of the same duration is still above the historical median. From this perspective, Swiss Confederation bonds still appear expensive. Nevertheless, the relative attractiveness of Swiss Confederation bonds compared to mortgage-backed bonds has increased significantly since the beginning of the year. At the short end (up to five years), the gap to the median spread between mortgage-backed bonds and Confederation bonds is 5 basis points smaller than at the long end. Accordingly, we see entry potential especially for Confederation bonds with maturities of up to five years, provided the spread narrows a little further.

There are increasing signs that now is a good time to enter the market

From a historical perspective, the spreads of almost all CHF bonds against the swap rate are currently at a very high level. The second column of the table below shows the spread premium of three- to eight-year bonds from various sectors. For mortgage bonds, the spread has only been higher than it is now on 5% of trading days (95th percentile) since 2020. Bonds issued by cities and cantons are also trading at a historically high spread over swap rates. Only on 8% of all trading days since 2020 has the spread been even higher. This suggests that now is a good time to enter the market, particularly for mortgage-backed bonds and bonds issued by cities and cantons.

Cantonal banks in competition with cantons

From a relative value perspective, we also see potential in bonds issued by cantonal banks to the respective cantons, assuming comparable credit ratings. For example, the spread premium of a bond issued by the Geneva Cantonal Bank (remaining term to maturity 3 to 8 years) is +37 basis points compared to a bond issued by the Canton of Geneva with the same term to maturity. Only on 7% of all trading days since 2016 was the spread premium over the canton even higher (93rd percentile). The bonds issued by Zürcher Kantonalbank pay an average premium of 25 basis points over bonds issued by the Canton of Zurich. For Zürcher Kantonalbank, too, the spread premium over the canton is above the historical median. For this reason, and where possible, we are overweight in the cantonal banks in our portfolios compared to the respective cantons. In doing so, we aim to actively add value for our investors.

Corresponding Fonds