Borrowing money globally has become increasingly difficult as central banks repeatedly buy back bonds, which could cause another shock to the world’s economies and financial markets. Bloomberg Economics predicts G-7 policymakers will shrink their balance sheets by around $410 billion for the remainder of 2022. This is a significant change from last year. , adding $2.8 trillion – bringing the total increase to more than $8 trillion since the outbreak of Covid-19.
Asset purchases by Central Banks in the G-7
That wave of monetary support helped lift the economy and asset prices through the slump. Central banks are trying to “calm down” as inflation soars to a multi-decade high. The dual effects of shrinking balance sheets and interest rate higher adds an unprecedented challenge to the global economy, which has already been affected by Russia-Ukraine tensions and China’s Covid-19 lockdown policies.
Their new policy is called quantitative tightening. This contrasts with the quantitative easing central banks have adopted during the pandemic and great recession, which can drive borrowing costs higher and deplete liquidity.
Right now, rising bond yields, falling stock prices and a stronger dollar are tightening financial conditions, not to mention the Fed starting to push for rate hikes. Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis SA, said: “This has been a major financial shock to the world. The consequences of the dollar’s illiquidity and appreciation have been devastating. it is obvious”.
IMF predicts growth in the second half of 2022 and 2023 lower than in January
The Fed is expected to raise interest rates by 50 basis points, with that, traders also see about 250 basis points tightening between now and the end of the year. Officials are also expected to begin slashing the balance sheet at a maximum rate of $95 billion a month, a shift faster than expected earlier in the year.
The US central bank will move towards this goal by allowing government bonds and mortgage-backed bonds to be held, rather than selling the assets it has purchased. Policymakers have left the option open, they could sell mortgage bonds and return to an all-Treasury portfolio at a later stage.
In 2013, plans on the Fed’s balance sheet confused investors and caused a period of financial turmoil. Stock markets and emerging-market currencies have tumbled as international investors withdraw. During this time, policy has been thoroughly communicated, both in the US and elsewhere. Asset managers have had time to set prices according to price effects, which will mitigate shocks in the market.
First time in history
So far, the Fed’s proposed cash outflow has led investors to demand a “cushion” for the risk of US holdings of long-term bonds. Term premiums are also on the rise, providing additional compensation when investors hold onto debt for a long time.
Fed officials say quantitative easing has helped lower yields by reducing term premiums, providing a stepping stone for the economy into a 2020 recession. quantity will have the opposite effect.
The Fed’s balance sheet disassembly is expected to be nearly twice as fast as it was in 2017, the last time it cut its asset holdings. According to Didier Darcet, fund manager at Gavekal Research, this magnitude of contraction and expected trajectory emerges for the first time in the history of monetary policy.
“Central bank tightening is trending slowly, will central banks push us into a recession,” said Kathy Jones, director of fixed income strategy at Charles Schwab & Co. Whether or not is still a matter of consideration.”
Fed and central banks try to expand their balance sheets
Some are cutting back on the risky assets they can anticipate. Asset management firm Robeco bought short-term bonds and cut high-yield, high-credit and emerging market bonds as it expected a slowdown in economic growth or even recession this year.
Liquidity flows are much more important and have a better correlation with equities, said Citigroup strategist Matt King. He estimates that every $1 trillion in quantitative tightening will send stocks down about 10% over the next 12 months or so.
For Chris Iggo, chief investment officer at Axa Investment Managers, this is the right time to buy bonds as a hedge in the event stocks take a hit from quantitative tightening and higher interest rates. . Mr. Iggo said. “Slowly increasing fixed income as yields rise will eventually create a more effective hedge in a multi-asset portfolio if equity returns fall short of expectations.”
Central bankers have argued that shrinking their balance sheets by allowing bond issuance should not be too sudden. The process was described by then-Fed President and current US Treasury Secretary Janet Yellen as “boring”.
The combination of quantitative tightening, short-term rate gains, a strong dollar, higher commodity prices and a contraction, said Gene Tannuzzo, global head of fixed income at Columbia Threadneedle Investments. America’s fiscal year has hit this country and the world by a huge wind. “The economy is facing a lot of things. Even without a recession, growth will be quite slow by the end of the year,” Tannuzzo said.
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