Central banks expected to tighten everywhere - BAML

Ralf Preusser, Research Analyst at Bank of America Merrill Lynch, suggests that their economists are looking for central banks everywhere to tighten policy – so unlike in 2016, they expect to see the Fed, ECB, BoJ, RBA, BoC and POBC to all withdraw accommodation simultaneously.

Key Quotes

“While each policy change individually may not be all that big, the concerted nature we think will have a meaningful impact on the market. There are three elements to this story:

• Mechanically it is the case for central bank balance sheets: the Fed’s holdings of USTs will decrease by 175 bn, while the US deficit is expected to reach almost USD 1 tn (from USD 630 bn in 2017); the ECB’s purchases will drop from EUR 780 bn to likely EUR 300 bn; the run rate of QQE has already declined 25% of the peak and may decline further as the BoJ adjusts its yield target; and while the BoE balance sheet is not expected to change, Brexit has taken a proverbial sledgehammer to public finance projections – with the cumulative additional Gilt supply since Brexit estimated to be GBP 118 bn over five years. And ironically, this is the first time that developed rates markets will see the supply of government bonds increase pro-cyclically, i.e., when central banks are tightening policy and growth and inflation are improving. 
• Second, 2018 will be the year where we expect to see short rates move up not just in the US, but also in Canada and Australia. And even the ECB may struggle to prevent a repricing of the front end. As a result the global shortage of yield will correct not just through the quantity of bonds on offer, but also the price of cash. 
• Third, the behavior of Japanese investors highlights that yield pick-up is not a good predictor of foreign demand. Japanese investors have turned into sellers of USTs as the US curve has flattened. The flattening of the curve alone considerably erodes the FX hedged return for non-US investors. Therefore even as the yield spread rises the incentive for foreign investors to stem the sell-off in the US does not necessarily increase. This will be particularly true in the scenario where the JGB curve actually steepens in 2018 on the back of tweaks to YCC.”