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Michael Howell: Is QE returning by stealth?

Section: Daily Dispatches

By Michael Howell
Financial Times, London
Wednesday, December 28, 2022

It has been a bleak year for many investors. Global investors have lost $23 trillion of wealth in housing and financial assets so far in 2022, according to my estimates. That is equivalent to 22% of global gross domestic product and uncomfortably exceeds the lesser $18 trillion of losses suffered in the 2008 financial crisis.

Hopefully though, next year will not be so bad for assets, because the cycle of global liquidity is bottoming out. Part of my reasoning is that quantitative easing programs by central banks to support markets are impossible to reverse quickly because the financial sector has become so dependent on easy liquidity. The very act of quantitative tightening creates systemic risks that demand more QE. 

... Dispatch continues below ...


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We track the fast-moving, global pool of liquidity -- the volume of cash and credit shifting around financial markets. The impact of the ebb and flow of this pool, currently about $170 trillion, can be seen in the central bank programs to support markets through the Covid-19 pandemic -- quantitative easing. The latter drove another "everything up" bubble through 2020-21. But as soon as policymakers hit the brakes in early 2022 and triggered a near-$10 trillion liquidity drop, asset markets collapsed.

We focus on liquidity because the nature of our financial system has changed. The markets no longer serve as pure capital-raising mechanisms. Rather they are capital-refinancing systems, largely dedicated to rolling over our staggering global debts of well over $300 trillion. This puts a premium on understanding collective balance sheet capacity to finance debt issues over analysis of the cost of capital.

We estimate that for every dollar raised in new finance, seven dollars of existing debts need to be rolled each year. Refinancing crises hit us more and more regularly. Hence the importance of liquidity.

So what now? 

According to our monitoring of liquidity data, we have just passed the point of maximum tightness. The two most important central banks driving the global liquidity cycle are the U.S. Federal Reserve and the People's Bank of China. Think of the Fed as mainly controlling the tempo of financial markets, given the dominance of the dollar, whereas China's large economic footprint gives the PBoC huge influence over the world business cycle. 

In short, the stock market's price-earnings multiple is determined in Washington and its earnings in Beijing.

The Chinese market enjoyed a large jump in liquidity injections in November, led by the start of an easier monetary policy from the PBoC. Contrary to the consensus view, latest data also show the U.S. Federal Reserve adding back liquidity into dollar markets, despite its ongoing QT policy.

Admittedly, the Fed has reduced its holdings of U.S. Treasuries in seven of the past nine weeks as part of QT. But net liquidity provision, benchmarked by moves in the Fed's "effective" balance sheet, has remarkably risen in six of these weeks. In fact, the Fed added an impressive $157 billion to U.S. money markets through its operations.

Looking ahead, we project a further pickup in global liquidity. China desperately needs to boost its lockdown-hit economy, so expect further policy stimulus in 2023. Two other favorable factors are the lower U.S. dollar and weaker oil prices.

We estimate that each percentage point fall in the dollar increases the take-up of cross-border loans and credit by a similar percentage amount. The U.S. currency is already down a hefty 9% from its recent peak. The fall in oil prices to below $80 a barrel should also help, reducing the amount of credit required to finance transactions.

But there could be more. The U.S. Fed plans to reduce its holdings of Treasury and government agency securities by $95 billion per month. But other items are likely to offset some of, perhaps even, all of this.

First, the $450 billion Treasury General Account, the U.S. government’s deposit account at the Fed, is likely to fall as bills are paid ahead of difficult upcoming debt ceiling negotiations. 

Second, the Fed's $2.52 trillion "reverse repo" facility for providing short-term investment to parties such as money market funds could drop significantly. This is because there are hints that the Treasury will issue more bills, debt of less than one-year maturity, relative to bonds, which have longer terms.

Third, rising interest rates mean the Fed will pay out more on debt it has issued. This could amount to a whopping $200 billion over 2023. 

The September turmoil in the UK gilt market was a reminder of the risks of financial instability when liquidity is withdrawn. Mindful of such forces, could the Fed be reluctant to push liquidity down too much? 

One could argue that by winding back its portfolio of Treasuries ("official QT") but allowing effective liquidity provision to rise ("unofficial QE"), the Fed is trying to have its cake and eat it!

Whichever, it surely shows that QT is harder to achieve in practice than in theory. Stealth QE may be back next year and make what looks to be a difficult year feel a tad better.


The writer is managing director at Crossborder Capital and author of "Capital Wars: The Rise of Global Liquidity."

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