Thoughts on "unwinding" QE from Frances Coppola
Major central banks around the world, like the U.S. Federal Reserve and the European Central Bank, are either on their way or at the very least contemplating reducing their balance sheets and raising interest rates after years of accomodative monetary policy. The Fed is further along in the process, aggressively tightening monetary policy having just last week raised interest rates for the third time in as many quarters.
Its plan to unwind its massive balance sheet of USD 4.5 billion accumulated during its six-year quantitative easing program from 2008 to 2014 will be put into action soon as well. The ECB, which began its own QE program in 2015, seems closer to ending QE with each monthly meeting as Eurozone inflation rises and economic growth firms up.
Both banks are at a crossroads as their respective decisions could be disastrous or come at just the right time. Recently, FocusEconomics contacted Frances Coppola, a regular contributor to Forbes and the author of the Coppola Comment finance & economics blog to get her comments on how both central banks should go about "unwinding QE."
Frances Coppola worked in the banking sector for 17 years and did an MBA at Cass Business School in London, specializing in financial risk management. She is the author of the Coppola Comment finance & economics blog, which is a regular feature on the Financial Times's Alphaville blog and has been quoted in The Economist, the Wall Street Journal, The New York Times and The Guardian. She is also a frequent commentator on financial matters for the BBC as well as a regular contributor to Forbes. She was also one of our Top Economics and Finance Bloggers of 2017.
How do you think the Fed will unwind its multi-trillion dollar balance sheet resulting from its stimulus program without severely upsetting the bond and equity markets?
Clearly, the Fed can't just sell down its asset holdings in one swoop. Balance sheet normalisation must proceed very slowly, to avoid serious disruption of bond and equity markets. Even if done slowly, we should expect a market correction of some kind, since the present inflated prices are in part due to the Fed's holdings: "what goes up must come down" is a useful rule of thumb here. It's not just bond and equity markets that would be disrupted if the Fed moves too quickly: there is a serious risk to real estate and commodity markets too. For the US, the prospect of disrupting the real estate market should give everyone pause for thought. Better not to normalise at all than risk a property market collapse.
Since you wrote to me, the Fed has announced its intention to start unwinding its balance sheet. I think of Fed's QE holdings as the mirror image of China's holdings of USTs. China sells them down as and when it needs more dollar liquidity. The Fed should sell its holdings down when it thinks the US needs less dollar liquidity. That would imply rising inflation, tight labour market and a softening dollar. Frankly that is not what I see, so I am wondering what the tearing hurry is.
That said, the global outlook is brighter, so it might be that the Fed is expecting demand in the rest of the world to lift the US economy and thus justify tighter monetary conditions. But I don't really understand this, since the Fed only has a mandate to consider domestic US conditions. Also, although the global outlook is brighter than it has been for a few years, political risk is so elevated that forecasts are decidedly fragile.
Tightening when the dollar is so strong is a serious cause for concern, since a strong dollar indicates global dollar shortage. Claudio Borio and Hyung Song Shin of BIS have both warned that the Fed's tightening is causing a global shortage of dollar liquidity, which is already having some very strange economic effects, such as breakdown of covered interest parity. We might find that a sudden squeeze on dollar liquidity forces emerging markets, especially (but not limited to) China, to sell down their UST holdings. Obviously the consequences for their currencies, and for global financial stability could be severe. We might also find that markets are distorted in strange ways that we don't expect and can't understand - the covered interest parity problem is a case in point. We are, to put it mildly, in uncharted territory.
To be fair to the Fed, their plan is for balance sheet normalisation to proceed at a glacial pace. But given the strength of the dollar since the taper tantrum in 2014, and the continuing fragility of markets priced in dollars (oil, commodities, metals), even a glacial pace could tighten global monetary conditions too much.
My considered view is that although I understand the Fed's desire to signal to markets that it intends to normalise its balance sheet, starting the process now - even at a glacial pace - is premature, given the strength of the dollar, below-target inflation expectations, continuing weakness in both the employment participation rate and wage growth, and elevated political risk. I regard the Fed's decision to raise interest rates and start unwinding its balance sheet under the present circumstances, both domestic and global, as verging on reckless.
How will the ECB, which is still stuck in a quantitative easing cycle, be able to bring it to an end without plunging Eurozone countries into yet another financial crisis?
I think the decision about when to end ECB QE will be dressed up as responding to market conditions, but the real driver will be inflation expectations in Germany. Inflation forecasts for Germany are rising, so I would expect ECB QE to be ended soon. But not necessarily unwound, since unwinding the balance sheet would be monetary tightening at a level inconsistent with the present path of inflation expectations. The ECB is also unlikely to want a stronger euro while inflation expectations remain below target and output is feeble.
As with the Fed, unwinding the balance sheet would have to proceed very slowly and cautiously. The ECB has all manner of junk on (or pledged to) its balance sheet, much of which does not arise from QE but from the alphabet soup of previous interventions. Initially, the ECB would do well to ignore all of these and concentrate only on selling down assets bought under QE, and strictly in accordance with the rules under which the assets were purchased.
Because of the dominance of banks in the European financial system, there is a serious risk to financial stability if the ECB causes a sudden bond price correction that undermines bank balance sheets. Therefore, I think the ECB should not attempt to unwind its balance sheet until all EU banks have stable and resilient balance sheets and the banking union has been completed. Also, because very low interest rates are a threat to bank solvency, particularly the large numbers of small banks in Germany and Italy, the ECB should raise interest rates some distance above zero before it considers normalising its balance sheet.
5-year economic forecasts on 30+ economic indicators for 127 countries & 33 commodities.
Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.
Date: June 19, 2017
TagsEconomic Growth (GDP)TunisiaUkraineSouth AfricaGoldChinaConsensus ForecastExchange RateAustraliaNordic EconomiesGermanyTPPAfricaEurozoneMajor EconomiesIMFBase Metals CommoditiesEmerging MarketsEconomic DebtArgentinaMexicoInfographicCryptocurrencyHealthcareUKIndiaCompany NewsUSATurkeyForexBrexitEuro AreaVietnamVenezuelaIranG7MENAHousing MarketUnited StatesRussiaSpainEnergy CommoditiesPortugalItalyColombiaGreeceEastern EuropeOilprecious metalsAgricultural CommoditiesUnemployment rateBrazilJapanInvestmentOPECFranceTradeSub-Saharan AfricaCanadaCommoditiesoil pricesAsiaLatin AmericaBitcoinEuropean UnionInflationBanking SectorPrecious Metals CommoditiesUnited Kingdom
Asia-Pacific economies are expected to maintain a solid pace of growth in 2019. Find out more in our latest economi… https://t.co/H9QUOIwqrD
2 days ago
2 days ago
Sub-Saharan Africa is projected to grow 3.4% in 2019, down 0.1 percentage points from last month's forecast. Find o… https://t.co/HH3x3XTScU
1 week ago
Asia-Pacific 2019: ESA to lose steam & ASEAN to maintain solid pace of growth - https://t.co/ABQAaNP2a3
1 week ago
FocusEconomics analysts expect South African growth of 1.4% in 2019, down 0.2% from last month’s forecast, and 1.8%… https://t.co/87vQ35B8ne
1 week ago
- Which will be the most miserable economies in 2019?
- Only by freeing Nigeria from its dependence on oil can Buhari truly take Africa’s giant to the next level
- An Analysis of President Trump’s 2020 Budget
- The World's Fastest Growing Economies
- President Sebastian Piñera aims to bring his elder brother’s private pension system into the 21st century
- Brexit Scenarios: Consensus of 14 Economic Analysts
- Sweden just formed a new government and approved its 2019 budget: what does it mean for the economy?
- Which countries have the highest public debt levels?
- Predictions for the global economy in 2019 from 13 experts
- Gurdgiev: Predictions for the global economy in 2019
- Daniel Lacalle's ideas for 2019: Change of cycle.
- Vietnam Poised to Profit from Free Trade Agreement Opportunities
- Pound Sterling 2019 Exchange Rate: Projections from Leading Analysts
- Canada in 2019: Interview with a Top Economic Forecaster
- Expectations for Latin America’s Economy in 2019
- Ethiopia and Rwanda: From Destruction to Development
- Key commodities trends to look out for in 2019
- What drove Gulf neighbors to bail out Bahrain?
- The Four Financial Bubbles and Their Impact on the U.S. Economy
- The Poorest Countries in the World
- Italy: The sick man of Europe
- What does Bolsonaro's presidential win mean for Brazil's economic outlook?
- The World's Top 10 Largest Economies
- In Latin America, taxpayers are tapped to shoulder the burden of a bank bailout
- How and when will the next financial crisis happen? - 26 experts weigh in
- China and Africa: A partnership under the spotlight
- The conditions are ripe for a Global Financial Crisis 2.0
- Uncertainty, instability and fear haunt a generation of Argentinians
- 5 things: What to expect for Mexico's economy in 2019
- 5 things: Brazil's economic downturn and what to expect going forward
- Emerging Market Currency Crisis: Everything you need to know
- Which ASEAN countries are most exposed in the event of a U.S.-China trade war?
- 75 Top Economics Influencers to Follow
- Emerging Markets Economic Outlook 2018 and 2019
- The Faces Behind Latin America’s Key Institutions
- 2019 Economic Outlook for the Top Oil Producing Countries
- Is your cup of coffee about to get more expensive going in to 2019?
- The Economic Implications of an Aging Global Population
- Can the Wisdom of the Crowds predict the results of the 2018 World Cup?
- Railway Mania: The Largest Speculative Bubble You’ve Never Heard Of
- From Riches to Rags: Have Cryptocurrencies Crashed for Good?
- Investment looks to Latin America, but forecasts are not encouraging
- Turkey: Erdogan has cemented his grip on power - now what about the economy?
- Mexico: A look at the past, present and future as elections yield AMLO victory
- How can Latin America’s business environment benefit from technological change?
- Italy’s New Populist Government and the Eurozone: Prelude to a Crisis?
- Latin America moves toward increased integration as U.S. protectionism grows
- How can Latin America increase productivity without affecting the quality of employment?
- How will Saudi Arabia's economy benefit from lifting the women's driving ban?
- Which countries are the most prepared for the upcoming digital revolution?
- India Under Pressure from the U.S. on Trade Policy
- The Story of Steel
- Latin America is the World Leader in eCommerce Growth Despite Serious Challenges
- What the TPP means for trade in Latin America
- Elections in Russia: Analysis and Implications
- Nearly a Third of Latin Americans Have No Right to a Pension
- A Look at Healthcare Models Around the World
- Newly-elected Chilean President Sebastian Piñera faces a myriad of challenges - economic and otherwise
- The Economic Effects of Trade Protectionism
- Regional Disparity: The Dark Side of Inequality in Latin America
- Coal: The story of the world's most abundant fossil fuel
- Gold: The Most Precious of Metals (Part 3)
- Venezuela's Electoral Conundrum
- Trump's 1st Year: 95 Analysts Surveyed on U.S. Economy
- The Latest on China and What's in Store for 2018
- An in-depth look at the Eurozone’s booming economy and the challenges that lurk in the shadows
- Increasing poverty in Latin America takes a breather thanks to improving economic dynamics
- Is Spain doing enough to address its high youth unemployment rate?
- Has Latin America gone far enough in reducing barriers to international trade?
- Commodities Outlook: Oil, Natural Gas, Coal, Lead & Tin
- 21 experts tell us what the future looks like for cryptocurrencies and blockchain
- Turkish lira plummets to all-time low on Erdogan’s monetary feud and tense U.S.-Turkey relations
- Copper: The first metal mastered by man
- Nigerian Economy Still Treading Water Thanks to Oil Sector
- The Mercosur-EU Free Trade Agreement: Obstacles & Opportunities
- Elections in Chile: What the results could mean for the economy
- QE’s Untold Story: A Chart That Fed Correspondents Need To Investigate
- Holland’s fragile one-seat majority government targets economic growth at the expense of fiscal sustainability
- South Africa: Economy at a tipping point?
- Latin American Commodities: What’s behind the increase in demand and prices?
- Is the UK really "shackled to a corpse"?
- Spain-Catalonia: 7 economic experts weigh in on how the situation will affect the outlook
- How well is Spain's labor market doing since the crisis?
- Which countries will have the highest and lowest inflation in 2017?
- How vulnerable is Latin America to economic crises today?
- Iron ore facts and common questions answered
- The bulging economic costs of obesity
- How much investment is needed to salvage Latin America’s crumbling infrastructure?
- A Look at the Potential Impact of Brexit on the Dutch Economy
- Emerging Markets Are Kicking Into Higher Gear In 2017
- Why is foreign direct investment in Latin America falling again?
- Are Central Banks Nationalising the Economy?
- Bounty or burden? The impact of refugees on European economies is far from clear
- What’s the future of U.S.-Latin America trade relations?
- Taxes or cutbacks? Latin America's challenge of sustaining spending without causing debt to skyrocket
- Are uranium prices making a comeback?
- Taxing the Economy: Achieving a Delicate Balance
- How will Latin America’s upcoming lengthy election cycle affect the reform agenda and credit ratings?
- How will emerging market economies perform in 2017?
- Chilean Economy in Focus: Interview with Senior Economist of the Chamber of Commerce of Santiago
- CEOs Rank Top Economies for Growth Opportunities
- The Mobile Ecosystem & Latin America's Economy
- Prospects and Challenges for the Global Economy: Interview with Tim Cooper from BMI Research
- How will the Fed reduce its balance sheet & and how will the ECB end QE? - 19 economic experts weigh in
- Thoughts on "unwinding" QE from Frances Coppola
- The Fed and ECB at a crossroads: Unwinding QE
- Spain: The economy that continues to silence the critics
- Latin America: The Most Unequal Region in the World
- The History of OPEC: Has it been a Success?
- FocusEconomics Announces 2017 Analyst Forecast Awards Winners
- Latin America’s rising unemployment bucks nearly decade long trend
- Escape from the Central Bank Trap by Daniel Lacalle
- China's economic rebalancing act: What to look out for in 2017
- Driving Growth in Latin America: Challenges & Priorities
- Is the Global Economy Rebalancing?
- Commodity exporters face challenging times
- Recent Global Events Facilitate Mercosur-Pacific Alliance
- 23 economic experts weigh in: Why is productivity growth so low?
- Mexico's outlook as Trump nears 100-day mark
- Interview with Oxford Economics Senior Economist on implications of the possible outcomes of the French Presidential Election
- The anxiety of the small saver in a world of negative interest rates
- Brexit negotiations. Between Uncertainty and Urgency
- An Economic History of the EU from El Blog Salmón
- Baby Boomin': Implications of high population growth in Latin America
- Survey of International Economists Predicts a Le Pen Defeat in French Elections, Says Macron has Best Economic Plan
- Spain in a global context: developed economy with some challenges
- How much is crime costing Latin America?
- Predictions & Estimates from Economist Daniel Lacalle
- What economy will the new Dutch government inherit?
- “The data is not a true reflection of reality in India” Interview with Société Générale India Economist
- What are the prospects for Emerging Economies in 2017?
- What to expect in Asia for 2017
- Top Economics & Finance Blogs of 2017
- Latam to Resume Moderate Growth in 2017 but Important Risks Plague Outlook
- 4 Key European Elections That Will Impact the Economy in 2017
- How are security concerns and political chaos affecting Turkey’s economy?
- Global growth to edge up in 2017
- Set to breach targets again? Debt and deficit outlooks for Southern European Eurozone countries in 2016 & 2017
- What does Donald Trump mean for the U.S. economy?
- How will emerging markets perform in 2017?
- The economic impact of a break in U.S.-Philippines ties
- Trump election: Base metals surge due to infrastructure plan
- 5 updates on the Venezuelan economic crisis
- Canada: When your neighbor’s house is on fire…
- Short-term pain before long-term gain? A look at French labor reform and economic growth
- Asia: Unremarkable growth & unfulfilled promises?
- How India's latest monsoon is affecting the economy
- Russian economy update in wake of OPEC deal announcement
- Innovation in Latin America: Potential Goes Untapped Due to Weak Economic Conditions
- The Wisdom of the Crowds and the Consensus Forecast
- Can the peso predict the U.S. election results?
- There's no end in sight to the Venezuela crisis
- A Look at the European Union Political Calendar
- Survey of international economists shows uncertainty surrounding elections damaging U.S. growth prospects
- FocusEconomics partners with leading online statistics provider Statista
- China: Recent postive economic data may be papering over the cracks
- Sub-Saharan Africa's 2016 & 2017 growth rates
- The Italian Dilemma: Weak banks pose risk to already faltering domestic demand
- How much money do migrants from Latin America send home?
- The U.S.' (Not So) Mysterious Case of the Missing Men
- What to expect from the G20 economies by 2020
- The Pain in Spain: Robust GDP growth cannot mask the persistent structural deficit