Central Banks’ Balance Sheets in Focus as Global Inflation Soars

The Federal Reserve building in Washington on Oct. 22, 2021. Daniel Slim/AFP via Getty Images

News Analysis

Inflation is swelling across both advanced and developing economies throughout the world, affecting a wide range of goods and services in the global marketplace. What does this mean for monetary policy in 2022?

Financial markets are betting on tighter monetary policy in 2022 as prices continue to spike in multiple sectors. Analysts are anticipating a steady withdrawal of stimulus and relief efforts, from gradual interest rate hikes to a modest trimming of quantitative easing (QE) programs. How much of an effect this will have on ballooning inflation is unclear.

Still, some experts say that a return to monetary normalcy will be a challenge after pumping trillions of dollars into the economy.

The Federal Reserve has initiated tepid tapering endeavors. The Bank of England has signaled that it’s preparing for rate increases. The European Central Bank (ECB) has been pushing back against tightening. The Bank of Canada appears confident enough in the nation’s post-pandemic economy to unwind QE and begin raising interest rates.

The euro sign in front of the former headquarters of the European Central Bank in Frankfurt, Germany, on April 9, 2019. Kai Pfaffenbach/Reuters

Balance Sheet Blues

Central banks everywhere have accumulated vast sums of assets to cushion the economic blows of the COVID-19 pandemic. In addition to possessing the traditional roles of regulator and supervisor, many of these institutions became participants in the economy, acquiring billions of dollars worth of corporate bonds and, in some cases, stocks.

As a result, the balance sheets of central banks have increased considerably over the past 20 months.

The Fed’s total consolidated assets stand at about $8.7 trillion. The ECB’s balance sheet is roughly $7.9 trillion. The Bank of Japan possesses approximately $7.25 trillion in total assets. The People’s Bank of China is estimated to hold $6 trillion on its books.

“Central bank policies remain on steroids,” said Jerome Jean Haegeli, the chief economist at Swiss Re AG in Zurich.

Some organizations will speed up the pace of ending these QE programs. Others, such as the Fed and ECB, will be waiting for more economic data, including jobs and gross domestic product, before pulling the trigger on accelerated tightening. Either way, Tavi Costa, a Portfolio Manager at Crescat Capital, said these institutions have decimated their balance sheets.

“What we are seeing is a new trend of creating and improving international reserves of central banks. That means buying gold to improve central bank balance sheets,” Costa told The Epoch Times.

He also believes that the renewed rally in gold has emphasized the need for monetary tightening.

Costa noted that central banks couldn’t shrink inflation by adding to the balance sheet and leaving interest rates at near zero. The Fed is projected to add $400 billion in assets until next summer despite tapering measures, while JPMorgan Chase & Co. economists are predicting that central banks in advanced economies will still add a net $1.5 trillion in assets to their balance sheets in 2022, with global rates slated to rise by just 11 basis points to an average of 1.48 percent.

“This is a macro regime change that will drive inflationary forces higher,” Costa said.

With inflation climbing to multi-year highs, there are calls for these institutions to speed up their tapering campaigns. But one central bank chief has said they need to take their time.

In an op-ed in Financial Times, Tiff Macklem, governor of the Bank of Canada, said that “monetary stimulus is still required” as economies continue overcoming the consequences of the global health crisis. Macklem said that ending exceptional policies is challenging, stating that it’s crucial to adjust a policy framework that takes into account changing circumstances.

“What our resolve does mean is that if we end up being wrong about the persistence of inflationary pressures and how much slack remains in the economy, we will adjust. Our framework enables us to do just that,” he wrote.

Will Market Exuberance Subside?

U.S. financial markets have been on a remarkable bull run as the leading benchmark indexes regularly post fresh record highs, thanks to a blend of fiscal and monetary support. However, as central banks start to trim asset purchases, market analysts agree that there’s still plenty of ambiguity about how the markets will respond in 2022.

ECB officials stated in their latest Financial Stability Review that this behavior of “exuberance” for nearly two years might make the equities arena “susceptible to corrections” as investors search for yield amid rising inflation and declining real interest rates.

“Concerns particularly relate to pockets of exuberance in credit, asset, and housing markets as well as higher debt levels in the corporate and public sectors,” the review reads. ”A correction in markets could be triggered by a weaker than expected economic recovery, spillovers from adverse developments in emerging market economies, a re-intensification of stress in the non-financial corporate sector or abrupt adjustments in market expectations regarding the prospective path of monetary policy normalization.”

Other strategists suggest that tapering could be good for stocks, citing the S&P 500’s history. Data compiled by CFRA Research show that, despite initial pullbacks in the May 2013 taper tantrum, stocks proceed to rally.

“After a very minor pullback known as the ’taper tantrum' stocks took off,” said Sam Stovall, chief investment strategist at CFRA Research. “Above average market returns across all styles, sectors, and up to 80 percent of all sub-industries.”

Although the S&P 500 slumped by nearly 6 percent in a month, Stovall said there’s a false perception of “a near-bear market.”

“It ended up being barely a pullback,” he said.

Market observers note that Fed Chair Jerome Powell might be studying lessons from history to determine the correct course of action and to avoid past mistakes. Powell, who’s nearing the end of his first term as head of the central bank, has stressed a more “patient” approach to normalizing, and, according to some economists, he has conveyed a message of disassociating interest rates and asset purchases.

“I think we’re learning that we have to be humble about what we know about this economy, which is still very COVID-affected,” Powell told reporters earlier this month after the Federal Open Market Committee policy meeting.

With interest rates and inflation becoming the focus for central banks and traders, wealthy investors have turned bearish on the market. A recent survey from Morgan Stanley’s E-Trade has shown that a growing number of affluent investors with $1 million or more in their portfolios think that the market will drop this quarter. Whether this attitude stays the same in 2022 remains to be seen.