Column: The markets are not prepared for the flight of liquidity from the Japanese and Swiss central banks
ORLANDO, Fla., June 23 (Reuters) – If estimates that global markets will face a record $4 trillion in liquidity drain over the next 18 months are even close to accurate, brace yourself.
That’s how much Morgan Stanley analysts believe the G4 central banks – the US Federal Reserve, European Central Bank, Bank of Japan and Bank of England – will shrink their balance sheets, via quantitative tightening (QT ), by the end of next year.
The estimate does not include the Swiss National Bank (SNB), one of the world’s largest liquidity providers of the past decade.
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Perhaps even more significant than the SNB’s 50 basis point interest rate hike last week was its admission that the franc is reasonably valued, suggesting that recent foreign exchange intervention years has come to an end.
If so, the SNB’s role as a marginal but steady buyer of US and Eurozone bonds, and Wall Street large-cap stocks, may be over.
The SNB’s balance sheet stands at about $1 trillion, up from about $200 billion in 2010. This represents an average of about $70 billion pumped into global markets each year that could now disappear.
This is a strong signal that even the world’s most dovish central banks are changing course. Although we are not there yet, an even bigger shock would be if the Bank of Japan (BOJ) reverses its “yield curve control” policy of buying unlimited government bonds for cap the 10-year yield at 0.25%.
In some ways, Morgan Stanley’s $4 trillion liquidity drain estimate is even more remarkable in that it predicts that the BOJ’s contribution will be essentially zero.
“The SNB and the BOJ have contributed to a very large injection of liquidity over the years, which has led to large inflows into the asset markets. If this were to stop, for whatever reason, it would be very dramatic,” said Jens Nordvig, Founder and CEO of Existing Data.
‘ZIRP’ & ‘NIRP’
Japan’s contribution to global market liquidity – via the BOJ’s unprecedented balance sheet expansion and purchases of foreign assets by Japanese investors – cannot be overstated.
The BOJ has used zero interest rate policy (ZIRP) and quantitative easing (QE) for years, and the country’s large accumulated current account surpluses have been reinvested in higher-yielding assets in the future. foreign.
Japan has long been the world’s largest creditor country and its net stock of foreign assets, accumulated over the past few decades in particular, reached a record $3.24 trillion last year.
The SNB, meanwhile, did better on rates and pushed them below zero – ‘NIRP’, or negative interest rate policy – and pumped out hundreds of billions of dollars of accumulated cash during of sustained foreign exchange intervention in large swaths of the world’s major bond and equity markets.
Unique among major central banks, the SNB is a listed company and also a huge investor in foreign stock markets. A quarter of its balance sheet is made up of foreign stocks, – a record share – much of it on Wall Street in multi-billion dollar stakes in companies like Apple (AAPL.O), Microsoft and Amazon.
BREXIT & SQUARE
Some of the world’s major stock and bond markets are posting one of their worst first-half performances since the Great Depression, as the Fed hiked rates, signaled more to come and just started trimming its balance sheet via QT .
As the following graph from Exante Data shows, the total amount of bank reserves created by the BOJ and SNB to purchase financial assets exceeds all others, as a percentage of GDP. The BOJ’s bank reserves amount to 104% of GDP and those of the SNB to 88%.
The hawkish kingpin of the SNB will eventually halt the accumulation of “demand deposits” via currency intervention weakening the franc, and the Nasdaq’s 30% drop this year could dampen its appetite to add to its stock portfolio by $177 billion.
As for Japan, purchases of foreign stocks and bonds by investors since the launch of “Abenomics” in 2013 have totaled around $15-20 billion per month on a 12-month moving average, with a peak in 2016.
Last year, however, they were sellers of foreign equities and their purchases of bonds slowed further. As Exante Data notes, they again this year resumed modest purchases of foreign equities, but turned short of foreign bonds.
But the yen just hit a 24-year low against the dollar around 136 yen, and by some metrics it’s the weakest in 50 years on a measure of the real effective exchange rate. Should inflationary pressures in Japan eventually take hold, the impact of a potential BOJ pivot would be enormous.
“At some point they are going to have to come out, and when they do it will be like one of those days that people remember in their careers, like Brexit, or for older bears, Plaza,” Marc said. Chandler, managing director of Bannockburn Global Forex, refers to Britain’s departure from the European Union in 2016 and the coordinated G5 effort to weaken the dollar in 1985.
– Full force of central banks siphoning off global liquidity (June 17) read more
– Nowhere to run, nowhere to hide as ‘stagflation’ bites (June 13) read more
The opinions expressed here are those of the author, columnist for Reuters
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By Jamie McGeever; Editing by Susan Fenton
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