On the 22nd of this month something will happen in the UK for only the second time when a government bond matures and is repaid. It comes from a consequence of the fact that the Bank of England now owns so much of the UK Gilt market ( our bonds are called Gilt-Edged because they were backed to some extent by gold which is sort of still true just that the Gilt-Edge is now incredibly thin, also @nickingib tells me that back in the day the Bank of England register had pages with a gilt edge). So we have this.
44: Consistent with the Committee’s decision at its February 2022 meeting to begin to reduce the stock of UK government bond purchases, the £3.2 billion of cash flows associated with the redemption of the July 2022 gilt held by the APF would not be reinvested.
Back in July a much large holding ( £27.9 billion matured) so we are on the road to a reversal of our QE holdings or what is called QE.
The United States began on the same road in June.
In accordance with the directive to the Open Market Desk, the reduction in SOMA securities holdings began in June, under the initial monthly caps on redemptions of
$30 billion for Treasury securities and $17.5 billion for
agency debt and agency mortgage-backed securities
(MBS). Under current staff projections, the SOMA
portfolio was anticipated to decline roughly $400 billion
by the end of 2022.under the initial monthly caps on redemptions of
These are the major moves for 2022 in this area as we see the UK with around £31 billion and the US with $400 billion as totals on current plans. We can look at the US rate of progress via the Financial Times.
The reversal is now well under way: just last week, its balance sheet shrank by roughly $20bn. And investors say it is already starting to hurt.
I counsel caution about looking ahead like this as so much is uncertain but here is the FT again.
All told, the balance sheets of the heaviest-hitting central banks will shrink by roughly $4tn by the end of next year, according to estimates from Morgan Stanley.
Also the FT is keen to imply that the ECB is involved in this when in fact it has done nothing and its “market fragmentation tool” is heading in the opposite direction.
Why?
There are two main reasons for this and the first is quite simple. As the US Federal Reserve and Bank of England raises official interest-rates they are raising the interest costs they charge on their QE portfolios. As their returns are fixed they are heading for losses. All very awkward for something which along the way boosted government finances when they bought bonds which paid more than a 0.1% interest-rate. Also they are now thinking about accounting for capital losses as bond prices fall.
To some extent I think some might have been worried about the scale of their operations as as the Bank of England bought £875 billion of UK government bonds and the US Federal Reserve balance sheet went above US $9 trillion.
Economic Effects
The simplest is that the money supply will fall. In specific terms some £3.2 billion will be received by the Bank of England later this month and the money supply will therefore fall and similar actions will take place in the US. Actually in practice it is much harder to see partly because we measure broad money supply in the UK or M4. As it has other factors in play things get muddied. For example the £27.9 billion QT in March probably led to the fact that April saw the weakest growth recently. But the last 3 months of UK broad money growth have been strong when you consider we have two things in play to reduce it ( QT plus higher interest-rates).
Whilst the US situation should be simpler as the have the M1 measure they did make it broader during the pandemic and there is also this.
NY Fed Accepts $2.17 Trillion In Reverse Repo Operations ( @PriapusIQ )
In essence by giving funds back to the Federal Reserve the money supply has already been reduced.
If it is any consolation the impact of QE on the way in was not always clear cut either although over time the impact on the money supply became clear.
Bond Yields
In theory these should rise but as ever it is more complicated than that. For example higher shorter-term interest-rates need to be factored in as well as the impact of the inflationary burst we are seeing.
The central bank equity market put option
The Financial Times tells us this.
Global stocks fell 8.8 per cent, the second-biggest drop in a decade. Bonds, meanwhile, are on track for the worst year since 1865.
I would take great care with the “1865” as I can recall worse years. They must be using a relative rather than an absolute definition. But they so then get to the point.
But some investors say another factor was also at play: the world’s most powerful central bank has yanked away its safety net.
Since 2008, fund managers in stocks, bonds and everything in between have known that by their side, the US Federal Reserve has been buying debt as part of its programme of economic support that kicked in after the financial crisis.
The idea that the US Federal Reserve would be like the US cavalry for equity markets has been in play for a couple of decades now. There has been a supporting cast of other central banks with notable mentions for the Bank of Japan with its Japanese equity purchases and the Swiss National Bank which bought US equities as part of its foreign-exchange hedging operation, or if you prefer its sideline as a hedge fund. Of course the SNB has recently stopped such activities but there is no sign of any selling yet.
Many might think ( and yes I am looking at the oil market) that the latter part of the whinge below may well be a good thing.
As a result, getting transactions done is becoming harder, Savry says, and speculative trading strategies have suffered “an end to the music”.
Comment
I hope that I have marked your card as to the likely state of play. There is an issue that comes from the fact that QE itself was misunderstood and that includes by the people doing it The Bank of England claimed it would increase inflation but in fact it went down various roads such as house prices which are conveniently excluded from its inflation measure. These days it has redacted such claims and hopes we wont notice.
Also there is the moral hazard issue.
“In credit, you had just a relentless search for yield. You could look at a [corporate bond] and buy it because the ECB was going to buy it, even if your credit analysts were saying they didn’t like the fundamental story.” ( FT)
Looked at like this central banks set out to destroy financial markets.
“One of the purposes of financial markets is to price risk. We allocate resources accordingly,” he says. “But we’re not pricing risk any more.”
Another way they did so was by reducing liquidity.
Exacerbating fears is the fact that Treasury liquidity is already significantly impaired, cratering this summer to its worst levels since March 2020, when the pandemic sparked a dash for cash and trading conditions for the world’s safest asset seized up.
Now let me switch to the next part o the story which is how long they can keep this up? After all conditions were better in 2018/19 when the US Federal Reserve turned tail on more minor QT efforts.
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