If estimates that global markets are facing a record $4 trillion liquidity drain over the next 18 months are anything but accurate, hold on.
That’s what Morgan Stanley analysts estimate the G4 central banks (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 providers of liquidity in the last decade.
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 the FX market intervention of recent years is over.
If this is the case, the SNB’s role as a marginal but steady buyer of US and Eurozone bonds, and large-cap Wall Street stocks, may be over.
The SNB’s balance sheet stands at around $1 trillion, up from $200 billion in 2010. That’s an average of about $70 billion pumped into world markets annually that could now disappear.
This is a strong sign that even the world’s most dovish central banks are changing course. While we haven’t gotten there yet, an even bigger shock would be for the Bank of Japan (BOJ) to cancel its “yield curve control” policy of buying unlimited government bonds to 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 the BOJ’s contribution will be essentially zero.
“The SNB and BOJ have provided a very significant injection of liquidity over the years leading to large inflows into the asset markets. If it stopped, for whatever reason, it would be very dramatic,” said Jens Nordvig, founder and CEO of Exante Data.
‘ZIRP’ and ‘NIRP’
Japan’s contribution to global market liquidity, through the BOJ’s unprecedented balance sheet expansion and overseas asset purchases by Japanese investors, cannot be overstated.
The BOJ has employed 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 abroad.
Japan has long been the world’s largest creditor nation and its net stock of foreign assets, accumulated over the past decades, hit a record $3.24 trillion last year.
Meanwhile, the SNB has raised rates and pushed them below zero (‘NIRP’, or negative interest rate policy) and pumped hundreds of billions of dollars of accumulated cash into sustained credit market intervention. currencies in bands of the main bonds of the world. and stock markets.
Unique among major central banks, the SNB is a publicly traded company and also a major investor in foreign stock markets. A quarter of his balance sheet is in foreign stocks, a record holding, much of it on Wall Street in multibillion-dollar stakes in companies like Apple, Microsoft and Amazon.
BREXIT AND SQUARE
Some of the world’s major stock and bond markets are having one of their worst first-half performances since the Great Depression, as the Federal Reserve hiked rates, signaled more are coming, and just started shrinking its balance sheet. through CT. .
As the chart below from Exante Data shows, the total amount of bank reserves created by the BOJ and SNB to buy financial assets towers over 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 SNB’s hawkish spin will eventually stop the buildup of “sight deposits” through currency intervention that weakens the franc, and the Nasdaq’s 30% drop this year could dampen its appetite to add to its $1 stock portfolio. 177 billion.
As far as Japan is concerned, purchases of foreign stocks and bonds by investors since ‘Abenomics’ was launched in 2013 have totaled about $15-$20 billion per month on a 12-month moving average basis. , reaching its peak in 2016.
Last year, however, they were sellers of foreign stocks and their bond purchases slowed even more. As Exante Data points out, they have resumed modest purchases of foreign stocks again this year, but have become sellers of foreign bonds.
But the yen just hit a 24-year low against the dollar of around 136 yen, and by some measures is the weakest in 50 years in a measure of the real effective exchange rate. If inflationary pressures in Japan finally take hold, the impact of a potential BOJ pivot would be huge.
“At some point they’re going to have to get out, and when they do it’s going to be like one of these days that people remember in their careers, like Brexit, or for the older bears, Plaza,” said Marc Chandler, managing director of Bannockburn Global Forex. , referring to Britain’s departure from the European Union in 2016 and the G5’s coordinated effort to weaken the dollar in 1985.
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