November 22, 2019
This past week, we’ve discussed the effect of expanding central bank balance sheets on stocks and the economy.
As Bernanke said in the depths of the financial crisis, it tends to ease financial conditions, which promotes lower mortgage rates and higher stock prices, which promotes economic growth.
But as we found earlier this year, in the post-crisis environment, removing global liquidity (prematurely) can create the opposite outcome. The combination of the Fed’s quantitative tightening program, and the ECB’s exit of its three-year QE program late last year, sent global financial markets haywire.
The aggregate balance sheet of the three most powerful central banks (the Fed, ECB and BOJ) in the world peaked in August of 2018.
Stocks went on to post a loss for the full-year, after being positive for the first three quarters. That’s the first time on record that happened. And it has the worst December since the Great Depressions.
Here’s a look back at the chart …
As we discussed in my August note, maybe most damaging factor was the “rate of change” in global liquidity. 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. That swung to a negative rate of change in a little more than a year. The world did not digest that well. And that has put the central banks back into action.
But the switch has been flipped. The aggregate balance sheet of the world’s most central banks has stopped declining, and has now returned to new record highs.