World Central Banks Start Turning Off Cash Taps

Global Central Banks Start Turning Off Cash Taps
As speculation grows about when the US Federal Reserve will begin reducing the size of its balance sheet, some analysts say the era of “quantitative tightening” has already started and “quantitative easing” is over.

Central bank balance sheets have ballooned since the pandemic struck global economies in 2020, but with economic recovery and soaring inflation forced central bankers to get to prepare the financial markets for a reversal to their bond-buying stimulus.

Markets tumbled this month at the prospect of the Fed hiking interest rates as early as March with quantitative tightening, namely tapering, namely shrinking of its $8.8 trillion balance sheet after it doubled in size during the pandemic, following afterwards.

Other central banks such as the European Central Bank are still likely to keep adding to global liquidity this year, offsetting some of that tightening meaning that while the rate of expansion in the overall central bank liquidity pool has been slowing since mid-2021, an outright reduction of balance sheets is not expected in the Eurozone until late-2022 or even 2023.

Bonk of America strategists expect major central bank balance sheets to stabilize rather than shrink in 2022, although as a percentage of GDP they estimate the major central banks will see a decline versus 2021 levels.

The US Fed, ECB, Bank of Japan, Bank of England, People’s Bank of China and the Swiss National Bank could collectively expand their balance sheets by $600 billion in 2022, below the post-financial crisis average of $1.8 trillion and 2021’s $2.6 trillion, but still a net addition.

However, the $600 billion forecast could turn negative if the Fed tightens faster than anticipated today. And a stronger dollar meant that for global investors, the five biggest central banks actually withdrew more stimulus in the three months to the end of December than they injected versus the preceding three months; the first quarter-on-quarter reduction since before the pandemic, according to his calculations.

Central bank liquidity flows
Fed’s tightening, driven by the end of quantitative easing, rate hikes and then QT, will result in a 4.7 percentage point rise in a US shadow real policy rate to -1.8% by the end of 2022.
This shadow rate rose 6 percentage points during the last tightening cycle, but that was over five years, between 2014 and 2019.

With central bank balance sheets towering above a huge $25 trillion, many observers say that even after some tightening liquidity will remain plentiful and rates historically low.

Negative inflation-adjusted bond yields suggest the party will continue but as Citi’s Matt King notes central bank stimulus flows are falling fast and “markets follow flows, not levels”.

JP Morgan strategists point out that excess money supply, the balance of gross money supply versus money demand, has been falling since May by one measure, and the decline in “excess liquidity” is set to accelerate this year.