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(Bloomberg View) -- There has so been much attention paid to the Federal Reserve recently in terms of what policy makers are saying and doing that it’s time to correct some observations.
At its June policy meeting, the Fed announced it would begin shrinking its balance sheet by $10 billion a month. And it has, with assets dropping to $4.439 trillion from $4.476 trillion. But that’s de minimus when you consider that its assets have grown from less than $1 trillion back in 2008.
Put another way, “normalization” has been a much-vaunted word used by the members of the Fed, but nothing of the sort has occurred. We are being bamboozled. Perhaps it will occur at some point, but it has not happened yet. “Flatlining” and “exiting” are not the same propositions.
In any event, most central banks are expanding their assets, more than making up for any “shrinkage” by the Fed. Yardeni Research points out that the major central banks assets grew by $1.6 trillion in the last 12 months. What difference will it make if the Fed cuts back by $10 billion per month? Almost nothing -- not even enough to be considered a rounding error.
Global central banks now have $21.7 trillion in assets, and that figure is heading to $24 trillion by next September, according to my calculations. Where in this scenario is there any sort of “normal”? The combined actions of the world’s central banks have never happened before, so how do you characterize “normal” in that context? You can’t.
At least with the Fed, unlike many other central banks, there is very little credit risk in its holdings. The composition of its portfolio is basically U.S. Treasuries, government agency debt and agency mortgage-backed securities. Not much to be worried about here. However, the Fed is virtually unique in this regard. The Fed also has the least amount of assets relative to gross domestic product of the major central banks. At 23 percent of GDP, the Fed’s total assets compare with 40 percent for the European Central Bank and 93 percent for the Bank of Japan, according to Reuters. Switzerland is the outlier, with the Swiss National Bank’s assets totaling 127 percent of GDP.
What investors need to be aware of is the growing risk in the assets of these other central banks. The SNB is in a very risky position. Some 94 percent of its balance sheet assets lie outside the country. According to SNB data, about 20 percent is invested globally in equities, including $88 billion in U.S. stocks.
One central bank that I am becoming somewhat concerned about is the ECB. Yardeni Research pegs its assets at $5.2 trillion. Here, it’s not just a question of size, but also of composition.
Beginning in June 2016, the ECB started to buy corporate bonds. It now holds about $152 billion of such debt, according to its own data, and it’s planning to purchase more. The bonds that it owns of one company, Steinhoff International Holdings, are in serious trouble. Notes issued by a Steinhoff unit plunged as much as 41 cents on the euro to 42 cents after Steinhoff said Wednesday that it was indefinitely delaying the release of its results, citing a criminal and tax investigation in Germany that dates back to 2015.
It will be interesting to see how the ECB reacts as its rules are quite fuzzy about what to do in situations like this. According to UBS, the ECB holds 26 bonds rated below investment grade, or “junk,” amounting to $21.2 billion in notional debt.
As we head into 2018, my focus continues to be “On the Money.” As long as new money is being printed, then I believe the trend in markets remains toward higher equity prices; lower Treasury yields; and risk assets compressed, ever tighter, against their benchmarks. Regardless of the protestations made by the Fed, and the other central banks, the flow of “pixie-dust money” has not relented. I remind you of the Wall Street adage: “Act on what they do and not on what they say.”
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mark Grant is a managing director and chief strategist at Hilltop Securities.
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