Central-bank balance sheets are expanding to record levels amid their latest buying spree, raising questions about how big they can get and whether those assets can ever be sold back to markets.
Policy makers didn’t have much luck paring down much smaller portfolios in the decade since the financial crisis. And now they have to bankroll a coronavirus economy that’s putting government budgets under unprecedented strain and threatening to drive companies everywhere out of business.
“The amounts being purchased are enormous, and it just tells you how much support is needed when the economy is closed down,” said Torsten Slok, Deutsche Bank’s chief economist. “Just have a look at how long it took to unwind from the financial crisis of 2008 and 2009. Now we are adding at a pace that is multiples faster.”
Central banks in Group of Seven countries purchased $1.4 trillion of financial assets in March, nearly five times as much as the previous monthly record set in April 2009, according to a Bloomberg Economics analysis. Morgan Stanley analysts estimate that the Federal Reserve, European Central Bank, Bank of Japan and Bank of England will expand their balance sheets by a cumulative $6.8 trillion when all is said and done.
The Fed has led the charge, offering to buy unlimited amounts of U.S. government bonds and mortgage-backed securities — and lend trillions more to corporations and municipalities through temporary purchases of their obligations — as global investors seek to unwind years worth of accumulated leverage in their own portfolios. In the week through April 15, it expanded its balance sheet at a pace of about $41 billion per day.
Central bankers in the euro area, Japan and the U.K. — old hands at so-called quantitative easing programs by now — have all ramped up buying, while those in Canada, New Zealand and Australia have embarked on large-scale purchases for the first time, joining Sweden among smaller economies to do so. There’s even talk that some emerging markets like Thailand may get in on the game.
“They’re all moving in the same direction,” said Aditya Bhave, an economist at Bank of America in New York. “At some point, unconventional easing stops being unconventional.”
In the coming months, as market liquidity is replenished, monetary authorities will shift their focus to the long haul of keeping borrowing costs low to facilitate a recovery and make it easier for governments to fund their budgets. While that may involve a slower pace of asset purchases, it certainly won’t mark a reversal, so the great balance-sheet expansion will roll ever onward.
When it comes to the question of whether there’s any effective limit on how much central banks can buy, Japan’s experience may offer a guide.
The QE pioneer first embarked on a program of large-scale asset purchases in 2001 after bubbles in its stock and property markets burst, plunging the economy into a deflationary spiral. It has made a couple of attempts to unwind in the intervening years, only to find itself repeatedly dragged back into more purchases.
Today, the BOJ’s balance sheet is 604 trillion yen ($5.6 trillion) –more than the nation’s annual economic output. The Fed, at $6.4 trillion or roughly 30% of GDP, seems modest by comparison while the ECB figure is around 39%.
Where Japan’s central bank is running into problems is market functioning. Its huge bond holdings, 43% of the total, impose limits on liquidity. The BOJ had to start selling and lending bonds recently due to the scarcity of supply, when investors demanded more of them as safe investments or as collateral to obtain U.S. dollars.
The BOJ also owns about 5% of the nation’s corporate bonds and around 5% of the stock market through exchange-traded funds. And while the Fed has said it will also buy ETFs under its new temporary corporate credit purchase programs — including some junk debt — it may not be inclined to buy much if volatility in credit markets remains relatively low.
“For now, both the Fed and the ECB will continue to ramp up their buying,” said Yoshinori Shigemi, a global market strategist for JPMorgan Asset Management Japan Ltd. in Tokyo, but they won’t get anywhere near Japan’s levels. “If the market eventually starts calming down, they don’t need to force themselves to buy more.”
When QE swept up much of the developed world after the financial crisis, critics warned of unintended consequences, like runaway inflation and moral hazard for financial institutions and even governments that had fewer reasons to balance the books. The first of those never materialized and the second is the last thing on the minds of policy makers grappling with one of the darkest economic outlooks since the Great Depression.
Richard Clarida, the Fed’s vice chair, said in a recent Bloomberg TV interview that if anything, the central bank is trying to guard against disinflation as demand plummets, adding that moral hazard concerns “aren’t relevant considerations” because the pandemic “is an entirely exogenous event.”
The buying so far has helped stabilize financial markets, shining a spotlight on another longstanding criticism levied against central bankers: their actions ensure swift relief for investors, while working people dependent on labor income have to wait for the help to trickle down.
Providing companies with a stable source of funding helps many of them stay afloat, but it doesn’t ensure that those companies retain employees. Indeed, market volatility has receded in recent weeks even as unemployment soars.
Once the dust settles, the balance sheets of monetary authorities will probably remain pumped up and benchmark interest rates will stay low for the foreseeable future. And if history is a guide, they’ll need to tread lightly as they slow purchases, let alone reverse them.
In 2013, U.S. Treasury yields shot higher in the ‘Taper Tantrum’ as the Fed contemplated stepping down the pace of purchases. It was only able to begin unwinding its balance sheet in 2017 — nine years after it initially began expanding it. But it didn’t get very far and even the small, gradual reduction it achieved was met with occasional bouts of market turmoil.
This time around, with more and more assets on more and more monetary authorities’ ledgers, the prospect of any rapid sell-down seems distant.
“We just have to get used to a new world where central bank balance sheets are so much bigger,” Deutsche Bank’s Slok said.