Pro Perspectives 8/16/19

August 16, 2019

Yesterday, we talked about the one-two punch from the Fed and ECB last December, that set up for a global liquidity shock.

Let's take a look closer today …

As we know, the Fed went on a three year monetary policy "normalization campaign."   

But the view from the Fed proved premature.  After an initial hike in late 2015, the global economy found trouble again.  And by early 2016, the Fed was forced to stand-down. They didn't hike again until Trump was elected, and the prospects of aggressive pro-growth policies were coming down the pike. 

Leaning against those policies, the Fed hiked another 200 basis points over 25 months. And at the beginning of 2018, they began "quantitative tightening" (i.e. shrinking their balance sheet).   

Since January of last year, the Fed has removed $642 billion from the global economy.  Meanwhile, the BOJ was continuing to pump about $25 billion a month into the global economy.  And the ECB was good for about $20 billion.  The ECB and the BOJ not only served as the offset to QT, but they combined to represented a buffer against shocks to the global economy (still in 'do whatever it takes' mode).

But the balance sheet of the three most powerful central banks in the world peaked in August of last year.  And then the ECB quit QE in December. 

With that, as you can see in the chart above, the liquidity provided by QE has been on the decline.  But maybe most importantly, is the potential (if not noticeable) shock to the system created by the "rate of change."  In combination the three most powerful central banks had been pumping liquidity into the global economy at a double-digit rate throughout the post-crisis period.  Now we have a negative rate of change. 
This seems to be what is sending global bond markets haywire.  And appears to have forced the ECB to reverse course.  Yesterday, an ECB official said they need to announce a significant easing package at their September meeting.  

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