Daily Commentary BY THE CURVE TEAM –

Is Global Excess Liquidity Coming to an End?

24th of July, 2018

As trade tensions and the war of words between US and Iran continued, the big news was a potential change in monetary policy settings from the central bank of a major developed economy that was the big news over the past 24 hours.

So far it has been the Fed in the US who has lead the move towards the normalisation of monetary policy which has seen their overnight interest rates rise and unwinding of their balance sheet commence. The ECB is slowly following in their footsteps and has  flagged an end to QE later this year before looking at their overnight interest rate mid next year.

Reports surfaced yesterday that the other major proponent of quantitative easing, the Bank of Japan, could be the next to follow suit and adjust their current setting of monetary policy. The rumour was that they will look to adjusted their Yield Curve Control policy and let longer rates start to drift higher.

In response to the report the BoJ said it would offer to buy unlimited Japanese Government Bonds to keep a lid on longer rates but it seems only a matter of time until they follow moves by the Fed and ECB to wind down their quantitative easing program.

The big three central banks have on balance been pumping money into global financial markets for the best part of a decade so signs that we are about to see this reverse are very important.

The impact of the move by the Fed to run down its balance sheet has already been seen in global markets and once the ECB, and eventually the BoJ, follow suit, the excess of global liquidity will start to dry up.

The market implications of the reduced demand for government bonds as net purchases from central banks disappears, all other things remaining equal, should push rates higher. That was reflected in market moves overnight with long bond rates around the globe all moving higher.

This is something that needs to be watched closely as higher longer term rates will have implications for a number of markets, including here in Australia.

David Flanagan

Director - Interest Rate Markets