The worldwide transition away from cheap money intensifies as central banks stop their pandemic bond-buying binge, posing another jolt to the world’s economy and financial markets.
Bloomberg Economics projects that policymakers in the Group of Seven will reduce their balance sheets by around $410 billion in 2022.
It is a significant contrast to last year, when they added $2.8 trillion, bringing the total expansion to almost $8 trillion since the arrival of Covid-19.
This wave of monetary support aided in recovering economies and asset markets following a pandemic recession. As inflation surges to multi-decade highs, central banks are reversing course.
Decreasing balance sheets and rising interest rates create an unprecedented challenge for a global economy already battered by Russia’s invasion of Ukraine and China’s new Covid restrictions.
In contrast to prior tightening cycles, during which the US Federal Reserve acted alone in lowering its balance sheet, others are anticipated to follow suit this time.
Their new approach, dubbed quantitative tightening (QT) — the polar opposite of the quantitative easing employed by central banks during the epidemic and the Great Recession — is expected to increase borrowing costs and deplete liquidity.
The Fed is anticipated to raise rates by 50 basis points at its policy meeting on May 3–4 and numerous times following, with traders anticipating around 250 basis points of tightening between now and year’s end.
Additionally, officials are likely to reduce the balance sheet at a maximum monthly rate of $95 billion, a faster pace than most anticipated at the start of the year.
The central bank of the United States will do this by allowing its holdings of government bonds and mortgage-backed securities to mature rather than aggressively selling them.
In 2013, the Fed’s balance-sheet ambitions surprised investors and precipitated a period of financial turbulence dubbed the “taper tantrum.” The policy has been well communicated this time, both in the United States and overseas.
The Fed’s rate of balance sheet unwinding is estimated to be nearly double that of 2017. Others follow suit: The European Central Bank has indicated that it will conclude quantitative easing in the third quarter, a timeframe complicated by the fallout from Ukraine’s war.
In February, the Bank of England began shrinking its balance sheet when it ceased gilt reinvestment. It is projected to raise rates again in May, raising the benchmark rate to the point at which policymakers would consider active asset sales.
The Bank of Canada’s passive balance sheet roll-off — in which it refrains from purchasing new bonds when existing ones mature — is likely to result in a 40% reduction in its holdings of government debt over the next two years.
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The Bank of Japan stands out because it is still committed to asset purchases — which it has had to increase in recent weeks to maintain its objective of managing bond rates. In the process, the yen fell to its lowest level in two decades.
China, which resisted quantitative easing during the crisis, has shifted into stimulus gear with tailored measures to support small enterprises.