Last week the European Central Bank indicated it was preparing to cut its crisis-era stimulus programme faster than expected, joining central banks from developed economies much sooner than many had expected, but at the same time as they expressed confidence in the global recovery.
The signal was in the minutes of the ECB’s December meeting with the subtle, but clear language we expect from the ECB, following on from a similar move by the Bank of Japan. The Japanese central bank sent the message by disclosing that it had purchased fewer bonds than many investors and traders had expected as part of its ongoing QE stimulus efforts to boost the Japanese economy.
This story of central banks starting to slow down their bond buying is not anything new for the markets, and truthfully is a worrying development in terms of the stability of global markets as we work through the start of 2018. Over the last couple of weeks, the 10 year US Treasury yield has touched a 10 month high, with the US dollar index falling to almost 3 year lows. This time after reports out of China suggested that officials reviewing the countries FX holdings suggested buying less Treasuries, due to the fact that they look less attractive relative to other assets.
But why is China so important to the global bond picture? The issue lies with the global central bank picture, and really the global economic recovery. Deep in the financial crisis of 2007-2009 the global economy was on its knees, Lehman Brothers had collapsed, banks were being bailed out, jobs were being lost and homes repossessed. The only way to end the madness was to pump trillions of dollars in to the economies, cut the rates and prop up the whole system.
Well that was 10 years ago, the world has recovered, and yes the stimulus and QE packages have worked. Now they need to be removed or at least reduced, and our economies must stand on their own, grow and function. There are two things an economy needs to be able to function, spending and lending, and finally the banks are lending money on their own and the public is spending it.
Over the last 10 years though the process of QE has meant that governments have been buying bonds, and mainly government bonds at a continuous rate, but as they slow down there is likely to be a shortfall in the bond market. Central banks have always bought government bonds, and when one stops there has always been another to step into its place and fill the short fall in treasury purchases. That is no longer the case, all Central Banks are in the same boat. The the 07/08 financial crisis mean all central banks from developed nations lept into multi trillion dollar QE plans. So now, when the market needs another bank to make up for the shortfall of the Fed or ECB easing back, there are no options as all the central banks are in the same situation.
The amazing stat is that since 2008 global bond buying by central banks due to QE and stimulus program is now well over $16 trillion. However expectations are for 2018 to be the year that the Fed starts to withdraw stimulus from their balance sheet, adding this to the cut in bond buying by the ECB in 2018 and the BoJ in 2019.
The effect on the bond, and furthermore the stock markets are the unknown quantity at the moment, with expectations that draining the QE bowl could well result in US 10 year bond yields jumping from their 2.5% level to 2.9% by the end of 2018. With the UK gilt and German Bund seeing similar rises in yields. So with stock markets continuing to rise, its worth noting caution. Without a substantial bond buying program away from Central Banks, the shortfall could well be just too much for the market to absorb.
No matter how much Donald Trump wants to shout from the rooftops about the US recovery and stock market performance. Without his tax plan showing almost instant results, there is likely to be a major market shock at some point in 2018, when the bond buying short fall hits home and the Tax plan isn’t quite living up to expectations.
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Ongoing rate curve repricing and risk asset reaction perfectly illustrate how worryingly reliant investors have become on easy money policies