Column: Draining the Money Pool – Guessing the “Excess”.

REUTERS/Dado Ruvic/Illustration

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LONDON, Jan 14 (Reuters) – As central banks begin draining the money pool to halt a surplus fueling sky-high inflation, assessing how much liquidity is “surplus” becomes crucial for world markets .

An aggressive New Year’s blitz from the US Federal Reserve in the face of 7% inflation and near-full US employment has caused markets to price in as many as four US interest rate hikes this year.

But more pressing for many in financial markets are the Fed’s signals that it is already time to siphon off some of the money it has poured into the banking system through emergency asset purchases — money aimed at bolstering the economy in general during the shocking Keeping pandemic lockdowns afloat.

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Surprisingly for many investors, the Fed’s discussion of trimming its bloated $8.7 trillion balance sheet began at its December policy meeting, while it agreed to phase out new bond purchases in the first quarter of 2022.

While the apparent urgency to begin shrinking the balance sheet seems odd compared to plans to add more by March, many Fed officials have been insisting this year that the process must begin soon. But when and how quickly?

In an interview with Reuters this week, Atlanta Fed Chairman Raphael Bostic was the most vocal. Continue reading

Bostic expected the runoff election – which would initially consist only of maturing the Fed’s bond holdings without reinvesting the proceeds – to begin shortly after the first rate hike in March.

But he also said this so-called “quantitative tightening” (QT) should be powerful at $100 billion a month, twice as fast as the last balance sheet tightening in 2017-2019, and he identified $1.5 trillion Dollars of pure “excess liquidity”. which had to be taken out before the impact could be assessed at this time.

It wasn’t clear where Bostic got the $1.5 trillion from, but it’s roughly equivalent to what the Fed has had to withdraw from money markets overnight through “reverse repo” operations every day for the past few weeks.

On Wednesday, Cleveland Fed Chair Loretta Mester — a voting member of the Fed’s FOMC this year — agreed with Bostic, telling the Wall Street Journal she believes the balance sheet should be trimmed as soon as possible without the disrupting markets. But she went a step further, saying the Fed shouldn’t rule out the possibility of an active sale of its assets.

So the Fed seems to be taking this pretty seriously all of a sudden, and the market insiders have been working overtime.

JPMorgan chart on net G4 QE forecasts
JPMorgan chart of global credit growth


JPMorgan Flow and Liquidity Specialist Nikolaos Panigirtzoglou and his team conclude that the peak of what they see as global “excess money” is now far behind us and its proxies for broad liquidity in the coming years two years will shrink significantly.

The JPM team now expects the Fed to QT in July after the second rate hike, and assuming that by the end of this year they will have a monthly outflow pace of 100 billion in debt from sovereign and sovereign borrowers in the second half of 2022 and about 1 trillion US dollars in 2023.

Fanning that out to its measure of global net bond supply versus demand, it now sees that position deteriorate by about $1.3 trillion this year compared to 2021. And based on historical correlations, JPM believes that returns on global bond aggregate indices should typically rise by another 35 basis points.

Another direct impact on Fed QT liquidity is the reduction in commercial banks’ reserve balances held with the Fed, and thus their lending capacity. While this will be offset globally this year by continued asset purchases by the European Central Bank and Bank of Japan, JPM expects it to hit harder in 2023 as those central banks ramp new bond purchases closer to zero.

As a result of a slowdown in central bank bond buying flows and a slowdown in global credit demand due to pandemic spikes, they see their estimate of global monetary growth picking up from a pace of $7.5 trillion last year to $3 trillion in 2023 than halving and returning to annual growth rates not seen since 2010.

Will this have burned estimates of “excesses”? Looking at global “surplus” proxies, which measure global monetary growth relative to nominal GDP or the ratio of cash relative to household stocks and bonds holdings, JPM believes the surplus is already gone.

Everything under control? Will this be enough to curb inflation and runaway markets?

Pascal Blanque, Amundi’s Chief Investment Officer, believes we will see a new 1970s-style inflationary regime, largely because governments simply need to take greater control of money and lending rates from their central banks — as post-COVID recovery and climate change require fiscal expansion.

“In this new regime, governments will take control of money while maintaining widespread and double-digit monetary growth for several years, as part of a broader transition from free market forces, independent central banks, and rules-based politics to command-based politics. oriented economy.”

Blanque posits that the reason the rising money supply hasn’t fueled inflation over the past decade was that a decline in the so-called velocity of money — or the rate at which a dollar is used in transactions — in the real economy was merely transferred to financial assets.

Taking the real and inflationary spheres as one, velocity may have been as stable as monetary theories assume, he wrote, and continued money pumping will eventually prove inflationary — even coincidental, for periods in both consumer and consumer markets in asset prices, like now.

US money supply and velocity
Total balance sheets of the G4 central banks

The author is the finance and markets editor at Reuters News. All views expressed here are his own.

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by Mike Dolan, Twitter: @reutersMikeD Editing by Mark Potter

Our standards: The Thomson Reuters Trust Principles.

Virginia C. Taylor