Major central banks, already plotting interest rate hikes in a fight against inflation, are also preparing a common pullback from key financial markets in a first-ever round of global “quantitative tightening” expected to restrict credit and add stress to an already-slowing world economy.
The US Federal Reserve and its major counterparts in Europe, Japan, the United Kingdom and elsewhere pumped around $12 trillion into the financial system to fight the economic fallout of the coronavirus pandemic, buying an array of assets and in some cases offering long-term loans to banks in a massive bout of quantitative easing.
With breakout inflation now the common fear, they are reversing course. Morgan Stanley analysts recently estimated the Fed, Bank of England, European Central Bank and Bank of Japan could see their portfolios shrink by $2.2 trillion over the 12 months beginning in May – the expected peak of QE.
The International Monetary Fund on Wednesday cut its estimate of 2022 global economic growth to 3.6 percent from 4.4 percent, and warned in doing so that changes in central bank balance sheets “may present additional challenges.”
“Clear communication on plans to unwind the unprecedented expansion of central bank balance sheets…will be crucial to avoid unnecessary market volatility,” the IMF warned. “A disorderly tightening of global financial conditions would be particularly challenging for countries with high financial vulnerabilities.”
Estimates around the impact of “global QT” are preliminary, and the Fed in particular may prove more aggressive if, as many analysts expect, it shifts later this year from letting maturing securities simply expire to outright sales of some assets to speed the process.
It is a unique moment. The 2007-2009 global financial crisis also unleashed a wave of quantitative easing, but the following recoveries were never strong enough or provoked enough inflation to prompt a synchronized monetary tightening.
By removing powerful central bank buyers from markets important to setting global interest rates, like US Treasuries, the spillovers could matter.
“We need a tightening of financial conditions…But it is possible we will see changes in rates or changes in the balance sheet that induce more of an effect on financial conditions than we think will happen,” said Karen Dynan during a presentation at the Peterson Institute for International Economics, where she is a senior fellow. One risk is if QT’s impacts are felt in weaker economies with high debt levels and “cause a ripple of sovereign debt crises around the world that disrupts markets” and further tightens conditions in developed nations.
The pandemic continues to reshape global commerce with major parts of the Chinese economy on lockdown; the war in Ukraine has become a humanitarian tragedy influencing flows of fuel, food and industrial minerals worldwide; and inflation is surging to multi-decade highs, prompting developed-world central banks to align to quash it. – Reuters
