If you follow markets, you remember 2015 vividly.
Specifically, you remember it as the year that the “Great Accumulation” came to an end. Following the unceremonious death of the petrodollar in November 2014, EM and GCC FX reserves began to trend lower.
When China moved to devalue the yuan in mid-August, the pace of EM FX reserve liquidation (read: US Treasury sales) accelerated markedly as the PBoC fought to control the pace of the RMB’s path lower.
(Goldman)
That marked what Deutsche Bank called “Quantitative Tightening,” as it effectively functioned as QE in reverse.
So as the market frets day and night about the pace at which the Fed will shrink its balance sheet, Bloomberg’s Cameron Crise is out with a reminder that in reality, we’ve already seen this movie. And if the first screening was any indication, this may be “much ado about nothing.”
Via Bloomberg
As bond investors continue to debate the timing and impact of a Fed balance-sheet reduction, a funny thing seems to have escaped the notice of many observers: we’ve already had an episode where monetary authorities have reduced the size of their Treasury holdings.
- While the Fed holds some $4.2 trillion worth of securities on their own balance sheet, they also hold $3.2 trillion in custody for foreign central banks. Between July 2015 and November 2016, those custody holdings fell by some $268 billion as dollar strength forced other central banks to reduce their FX reserves and cash in some of their Treasuries.
- If anything, this figure probably understates the scale of foreign central bank sales. Belgian holdings of Treasuries are often seen as a proxy for foreign central bank ownership; in February-July 2015, these holdings dropped nearly $250 billion.
- A $500b decline in central bank Treasury holdings over a 21- month period is broadly comparable to the run-rate of the decline in Fed holdings should they cease reinvestment all at once.
- Over the period in which foreign CBs shed Treasuries, both U.S. equities and credit spreads were largely unchanged, albeit with significant pockets of volatility. Treasury yields were also largely unchanged, even after early 2016 when equities recovered and central banks were still selling bonds.
- The worst that you can say about central bank Treasury sales is that they coincided with a period of equity market volatility. Given the comments in the March minutes about the level of equities, a repeat performance may not be an unwelcome development for some members of the FOMC.
- Ultimately, the Fed’s deliberation over its balance-sheet policy may be giving the decision more significance than it merits. Ironically, foreign central bank Treasury holdings started to rise again after the election. If that trend continues after the Fed starts to unwind its balance sheet, bond traders might find that the whole debate was much ado about nothing.
