Shifting Gears on the cash spigot

Bloomberg – Quantitative Tightening to End as Central Banks Retreat – David Goodman & Liz McCormick 7/22/19

Net bond purchases by the Federal Reserve, European Central Bank and Bank of Japan will swing back above zero from September, according to an analysis of their balance sheets by Bloomberg Economics. That’s just eleven months since they collectively hit reverse having spent a decade pumping stimulus into their economies via quantitative easing.

The outlook shows how quickly central banks have been forced to turn tail after spending much of last year leaning toward tightening monetary policy, only to now be looking to loosen it as the world economy slows. It also underscores how their balance sheets are likely to remain permanently larger than the pre-crisis years.

For investors, the switch back, coupled with shifts toward lower interest rates, strengthens the case for buying bonds given the increased demand and shrinking supply of them. That could add fuel to a rally that’s already pushed average yields on global bonds down by almost 1 percentage point since November, left an almost $13 trillion pile of negative-yielding bonds and sparked predictions that U.S. 10-year borrowing costs could also hit zero. Those lower yields would tend to push investors back into stocks.

Since the Fed began reversing QE in October 2017, it has shed about $370 billion in Treasuries from its balance sheet which had hit $4.5 trillion in 2015. Those holdings will begin to rise later this year as the Fed ends the unwind and engineers plans to move back to pre-crisis norms of holding only government debt by slowly replacing its $1.5 trillion in mortgage-debt holdings with Treasuries.

“The Fed’s plans for the balance sheet are to shift out of MBS and into Treasuries and, given their guidance, they should be buying some bills,” said Mike Schumacher, strategist at Wells Fargo. “That will cause the curve to steepen.”

As for the European Central Bank, Bloomberg Economics is among those predicting it will announce in September that it will be purchasing bonds again. Its base case is that the ECB will start 45 billion euros of monthly net asset purchases to run for a year, starting in the fourth quarter.

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