“FUTURE REDUCTIONS IN
CENTRAL BANK DEMAND FOR
TREASURIES CAN PROVIDE THE
IMPETUS FOR AN UPWARD BIAS IN
and in the last eight years, cumulative net assets have risen by over $2
trillion. To gain some perspective on that figure, net assets grew by only
$1.4 trillion over the previous 19 years.
Higher rates closer?
This phenomenon can operate in reverse as well and here is where
you get the possibility of higher interest rates. Just as QE and balance
sheet expansion on an unimaginable scale had unknown effects, so
too would balance sheet reduction and a potential normalisation of
global short-term rates. This process is looking like it is coming closer
to becoming a market reality.
In September 2017, the Federal Reserve announced that it would begin
its programme for the normalisation of its balance sheet, beginning
in October 2017. While the reduction of the balance sheet will begin
extremely slowly, and will be reduced only by slowing the pace at which
maturities are reinvested, it is nonetheless a dramatic change. Thus far,
as of this writing, the markets have taken this initial step in stride, but
future reductions in central bank demand for Treasuries can provide the
impetus for an upward bias in longer-term rates.
In addition to the US Fed announcing its reduction in stimulus, the
ECB has been reassessing its QE programme and balance sheet size.
In the wake of its own September meeting, the ECB announced that its
October meeting would feature a discussion on how to reduce the pace
of their bond purchases.
In conclusion, no-one really knows what the net effect of the reversal
of QE programmes and moves away from a negative rate regime will be
to financial markets, particularly interest rates. If one follows the money
flows, however, a reasonable argument can be made that long-term
interest rates, particularly in Europe and the US, could be poised to rise,
perhaps substantially, from current levels.
The views expressed are the opinions of the writer and while believed reliable may differ
from the views of Butterfield Bank (Cayman) Ltd. The Bank accepts no liability for errors
or actions taken on the basis of this information.
Andrew Baron is the chief investment officer of Butterfield Asset Management.
He can be contacted at: email@example.com
cayman captive 2018 55
Veni / iStock Photo
maintain the current balance of securities at its high level by reinvesting
all maturities and principal repayments. In US dollar equivalents, the
Bank of Japan (BoJ) owns more than $4.5 trillion of securities (not only
bonds, but equities as well) and the European Central Bank (ECB) owns
more than $2.6 trillion.
Both central banks increased their holdings at a similar pace and
scale as the Fed, spread across slightly different timelines. The ECB
and the BoJ, unlike the US Fed, have not levelled off purchases and
have continued to grow their respective holdings. Numbers like these
can barely be comprehended and definitely do not fit into any contextual
relationship with economic history. Whether or not bond purchases by
central banks have had a direct causal effect on global interest rates,
interest rates have nonetheless remained suppressed.
Since the US never got to a place where short-term rates of interest
were negative, one of the features of the period of balance sheet
expansion, outside the US, was that it has caused investors to seek
yield-producing assets outside their home nations and currencies. The
US has been the beneficiary of these investment flows to the tune of
hundreds of billions of dollars.
Some portion of that investment flow finds its way to US Treasuries,
US corporate bonds and other dollar-denominated fixed income assets,
systematically pushing interest rates lower by constant demand for
dollar-based assets. The Investment Company Institute records data for
cumulative flows to US bond mutual funds and exchange-traded funds