Happy QT day!

[spygirl]

BoE to start selling bonds on Nov. 1, but not longer-dated gilts

https://www.reuters.com/markets/europe/boe-set-delay-quantitative-tightening-until-gilt-markets-calm-ft-2022-10-18/

[23rdian]

Let's see how long this lasts. I give the lettuce longer again. 

[spygirl]

It’s payback time for more than a decade of free money

Read this exclusive extract from our Economic Intelligence newsletter and sign up at the bottom of the article to get it every Tuesday

JEREMY WARNER1 November 2022 • 3:00pm

Bank of England Governor Andrew Bailey is 'flying blind' on reversing QE CREDIT: Yui Mok/Pool via REUTERS

Idon't want to enter the realm of conspiracy theory, so I'll start by disowning it. The Bank of England did not, as suggested by some, bring down the Truss government and her unfunded tax cuts, either deliberately or by accident via ineptly managed messaging. Liz Truss only has herself to blame for what happened. She took a major risk with the public finances, and it didn't pay off.

Yet as they begin the painful process of shrinking their balance sheets after more than a decade of on-off money printing (quantitative easing), central banks do indeed have quite a lot to answer for when it comes to the outbreak of instability we are witnessing in financial markets. They helped create current vulnerabilities. Truss's mistake was to assume they'd always be there to print the money. It has been a rude awakening.

All of a sudden, once-abundant liquidity is draining from the system; at the heart of this process is determination to reverse the excesses of QE. Both the scale and duration of past QE – particularly that associated with the pandemic – has made the financial system far more vulnerable to destabilising forces than it was, making it much harder to unwind QE without mishap.

The Bank of England is this week expected to raise the Bank Rate by 0.75 percentage points to 3pc, the highest it has been since the onset of the financial crisis in November 2008. 

But though interest rates may be returning to a semblance of pre-crisis "normality", central bank balance sheets remain mired in a kind of Alice in Wonderland alternative reality. With the exception of the Bank of Japan, which answers to an altogether different logic, central banks are determined to normalise this aspect of their affairs, too, in an effort to tame runaway inflation. 

The Bank of England, for one, is expected to resume asset sales this month, after temporarily suspending the programme in the wake of the unfunded tax-cutting fiasco. Given the mayhem that broke out then, and with the economy on the cusp of recession, is it entirely wise to be once again pushing ahead with so-called "quantitative tightening" (QT)?

By the beginning of this year, the Bank of England's balance sheet had swollen to nearly 50pc of the country's entire annual GDP. Britain was not alone in following this course. Total assets of the world's major central banks stood at a jaw-dropping $30 trillion.

In a paper co-authored with Rahul Chauhan and Sascha Steffen that was presented at the Federal Reserve Bank of Kansas City’s Jackson Hole conference in August, Raghuram Rajan, former governor of the Reserve Bank of India, argued that because of the financial sector's over-dependence on easy liquidity, QE has become far more difficult to reverse than central banks like to believe.

“Monetary policymakers thus find themselves in a very difficult position”, Rajan said in a recent article for Project Syndicate. “A central bank may need to raise rates to reduce inflation.

But if it also must simultaneously supply liquidity to stabilise government bond markets, it risks sending a mixed message about its policy stance – not to mention raising concerns that it has become a direct financier of the government…Our findings suggest that QE will be quite difficult to reverse, not least because QT itself increases the system’s vulnerability to shocks.”

Andrew Bailey, Governor of the Bank of England, has said he’s "flying blind" in having to make decisions on interest rates while not knowing what the Government's fiscal plans are.

Yet he also faces a different form of “flying blind” on quantitative tightening, with little idea how bond markets, or indeed the rest of the financial system, will react. It's a perilous path the Bank of England treads.

The idea that a certain amount of QT equals a certain amount of monetary tightening is just the half of it. Excessive QT might also cause a financial crisis; no one really knows where the vulnerabilities lie.

There has already been one false start. Having signalled £80bn of asset sales over the next year, the Bank of England was forced to do an abrupt about-turn when rising interest rates in the wake of the mini-Budget threatened the solvency of a number of big pension funds; the gilts buying spree was instead renewed.

The challenge for the Bank was to demonstrate that this was not renewed QE all over again. With inflation in double digits, it would have looked too much like monetary financing of the Government's borrowing needs if it had been perceived as such. So the message went out that it was a temporary and targeted programme to allow pension funds to build resilience to increased volatility.

All the same, in attempting to stem the rout, the Bank of England was also forced into buying inflation-linked gilts for the first time. This was a new departure, which added to the impression of fiscal dominance.

The Bank found itself caught completely off guard by the pensions crisis. There are no doubt plenty of other skeletons in the cupboard just waiting to leap out; there is little oversight of the shadow banking sector, said now to be even bigger in terms of assets than the banking sector itself. 

A Bank of England Financial Stability Report in 2018 did at least flag the vulnerability of so-called Liability Driven Investment strategies that lay at the heart of the pensions meltdown, but it had stress tested the system for only 100 basis points of movement in a single go.

This seemed reasonable at the time, as there had never been a sudden shift of this magnitude before, even after 9/11. Unfortunately, this one was much larger.

In any case, the immediate crisis in pension funds is over; time for a second stab at QT, the Bank's Monetary Policy Committee figures. For now, the Bank plans to limit asset sales to relatively short dated stocks.

This should soften the impact somewhat. Yet the Bank has also purchased much longer dated maturities, making its position somewhat more precarious than that of the Federal Reserve, whose QE was substantially targeted at the short end of the market. 

The US version of QT thus becomes comparatively straightforward. Much of the heavy lifting will be done via run-off, as short dated Treasuries mature.

The Bank of England's higher exposure to longer dated bonds means that were it to rely on run-off alone, it would take more than a decade to return the balance sheet to a more normal size. The Bank of England also arguably has a bigger inflationary problem, so it needs to move much faster.

Where, though, are the buyers? When gilts yielded a real rate of return, there used to be lots of them, but in the age of zero interest rates, there have really been only three or four sources of demand of any significance – legacy defined benefit pension funds, banks, the Bank of England, and foreign buyers – in offsetting funding Britain's current account deficit.

Well now the Bank of England has stopped, and pension funds are maturing fast, and foreign buyers are getting cold feet.

Support for sovereign bond markets is a lot less secure than it was, this at a time when debt issuance remains extraordinarily high. To attract investors, the natural rate of interest will therefore also have to be considerably higher than it has been for the past decade or so.

This may be a good thing, restoring some sense of sanity to markets that have become accustomed to free money, and taken it for granted. But the transition is going to be a mighty stormy one.

 

 

[23rdian]

Once money printing is available to governments why wouldn't they continue to use it. They may have to pause it for periods such as this but long term they will always go back to it once it's been established as an option. 

[HousePriceMania]

16 minutes ago, 23rdian said:

Once money printing is available to governments why wouldn't they continue to use it. They may have to pause it for periods such as this but long term they will always go back to it once it's been established as an option. 

They only got away with it because of the banking cartel doing this in unison.

They have bailed out the bankers with our money/future.

Being a cartel they've all agreed to stop now, Truss and KamiKwasi obviously didn't get the memo.

 

[23rdian]

51 minutes ago, HousePriceMania said:

They only got away with it because of the banking cartel doing this in unison.

They have bailed out the bankers with our money/future.

Being a cartel they've all agreed to stop now, Truss and KamiKwasi obviously didn't get the memo.

 

I only wish this was true. Everytime the US has tried QT they have had to back off after a short time. This will be no different IMO. 

Like I say, I hope I am wrong but governments don't have the balls to see it through. 

[HousePriceMania]

14 minutes ago, 23rdian said:

I only wish this was true. Everytime the US has tried QT they have had to back off after a short time. This will be no different IMO. 

Like I say, I hope I am wrong but governments don't have the balls to see it through. 

The governments now have no choice.