World Central Banks Doing The Heavy Stock Market Lifting

Summary

• Most large stock markets in the world have been supported by Central Banks since the GFC.
• There is a direct correlation between rising Central Bank balances and rising asset markets that investors can use to their advantage.
• Central Bank balances are a useful tool for trading movements in the stock market index in advance. Most stock markets lag the Central Bank balance by six to twelve months.
• The G20 Central Bankers and finance ministers met in Argentina over the last weekend, and one of the topics for discussion would have been the impact of their actions on markets and the need to buy.

The purpose of this article is to graphically show and describe how the central banks (CB) of most countries have been supporting asset prices with their balance sheets.

The central bank with the most experience in supporting markets is the Central Bank of Japan (BOJ). The chart below shows the long- and near-term efforts of the Japanese Central Bankers.

As can be seen on the chart above, Japan had a financial crisis in the early 1990s, similar to but much larger than the Savings and Loans crisis that occurred in the USA at the same time.

It took the BOJ a long time to step into the market; it let the markets slide for another ten years before reacting.

Making up for lost time, the BOJ has accelerated its efforts since the GFC, as can be seen in the chart below, with a strong correlation between the CB bank balance and the stock market direction.

The BOJ now buys everything: private debt, government debt and also stocks via ETFs, the last taboo. Similarly, when a CB buys a bond from a private bank, the private bank receives cash reserves in return. What it does with the excess cash reserves is up to the bank. Often, it is invested in other assets, such as foreign exchange or stocks. A good portion of this money finds its way the into markets. The origin of the money was the CB. Market support by proxy.

By far the largest supporters of markets are the Americans and the Europeans, as shown in the charts below.

Adding over $4 trillion to its bank balance, the Federal Reserve can be considered the mega-lifter of markets. The bad news for markets is that the support is now being taken away. It is no coincidence that the peak in the stock market this year in January has been followed by flat, choppy markets ever since the Fed's balance sheet began to fall.

The European Central Bank (ECB) has put in a similar performance to the USA, as the chart above shows. As Mario Draghi said, "everything, it takes to support the Euro," except fiscal spending on real benefits such as healthcare, education and infrastructure. More rising markets can be expected from the Europeans, as the stock market tends to follow the CB bank balance and it is still rising, and the markets will follow. Not all Europeans are equal, though.

Germany is by far the best bet. Rising CB bank balances mean rising markets.

This is not the case for other larger European markets such as Spain and Italy, for example. Shown above, the level of CB support is not enough to lift these moribund markets. The level of CB buying is not enough by one order of magnitude.

Given their self-imposed constraints via the fiscal compact (3% deficit and 60% government debt), they cannot marshal the funds to lift markets like the Japanese, Americans and Germans. The level of support is increasing though and has never been higher than now, and these markets could surprise to the upside.

There is a strong correlation between CB bank balances and most major stock markets, as the charts below show.

Canada long and short term. Above and below.

Australia has a very good correlation to CB bank balances.

The UK with and without Brexit, the CB is always there and the UK has one of the best correlations of the series presented here today.

India, long and short term. Above and below. CB support has dropped of late, and the stock market will most likely follow.

Russia below.

In all the above cases, except for Germany, Spain and Italy, the sovereign currency creation powers of the national government have been harnessed by the CB to support asset markets, rescue banks and suppress interest rates. This is a strategy that helps the holders of these assets. One could say that the banker class has rescued itself and those like it at the expense of the rest of the population. The rest have endured fiscal austerity and a loss of real benefits and lifestyle.

Germany, Spain and Italy are not monetarily sovereign in their currency, as they are users of the euro. Germany is fortunate in that it receives an influx of euros into its CB from its large current account surplus. Spain and Italy have the reverse situation. The ECB is the EU currency sovereign and has been doing some big-time asset market support via currency creation for bond purchases. At the same time, job creation programmes in the southern European lands could have solved the 25% general unemployment and 50% youth unemployment problem. What is more important? Inflating paper assets or employing and training the next generation of workers and consumers?

The same sovereign currency creation powers could have been used by the national government for fiscal expenditure on healthcare, education and infrastructure rather than misused by the CB for the inflation of paper assets.

Longer-Term Picture

There is an unfortunate global trend developing, as illustrated in the chart below from Mr. Robert P. Balan and this recent article.

The black dotted line on the chart above is falling in line with central bank balances as assets are sold.

The simple takeaway is that when the monetary base of the big global central banks falls, so do asset markets. The effect is already taking hold in America.

It has never occurred before that the world's central banks have unloaded their balance sheets all at the same time. QE has never occurred before on a global scale. QT has never occurred before. This is new territory. The way politicians and central bankers are mishandling this is a guarantee of a recession and stock market panic "that no one could foresee." They have to be different each time, otherwise they would not occur. It will be glibly termed a "Black Swan" event, an external shock that no model could predict except for Professor Steve Keen's Minsky Model.

There will be three broad effects:

1. Paper asset prices will generally fall as global central bank support is withdrawn.
2. Bond yields will rise and face values fall. The yield rises only because the face value has fallen.
3. The US dollar will soar as liquidity gets soaked up by the bond buying despite the "twin deficits."

CB asset buying is not something that one can stop doing, otherwise the very thing you are trying to save comes down again. At the recent G20 CB and finance minister meeting in Argentina, that would have been the elephant in the room.

For these people, there is no alternative (TINA), and one could expect that one of the less publicised outcomes of the meeting was the need to keep buying. Japan has been doing it for decades, and the others are likely to follow, there being no other choice outside of the taboo realm of national government Keynesian-style fiscal spending on first-class healthcare, education and infrastructure.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Denture Capital]

Although someone may say too slow to understand, after series of personal research, I am convinced that QE inflates asset prices. If this is true, QT should deflate the asset prices theoretically...

[Alan Longbon]

That is correct and the best description I have found for why is here:

www.youtube.com/...

Thanks for reading and commenting.

[EK1949]

Austrian economics is not primarily about how things work, though it is capable of describing how things work. What's it's mostly about, though, is how bad how things work is.

The giveaway is this. If you liken economic policy to driving a car one can learn how by watching and practicing under the guidance of a teacher, or take a course with a little booklet or some or all of these. Then you drive a car and get practical experience of your own.

Austrians don't necessarily disagree with these simple operations, they just think you should take a nonexistent bus. :-)

[EK1949]

"See Hazlit's 'Economics In One Lession', or Austrian Business Cycle Theory for more details on the secondary effects and net effects of government spending to 'manage' the economy."

All government spending is management. In a money system there is no possibility that the issuer of the currency issues it nowhere to nobody. Why would you think a government could "not manage" its central function, so central that everything it does spends or taxes money into or out of existence?

The concept is foolish and only exists to prop up a prejudice. It's never meant to be put in practice, and it's not possible that anyone would even try. If anyone would have tried it would be Paul Ryan and all he produced was rhetoric to limit functions disguised as the basis of an alternative plan. There is no alternative plan. There never will be an alternative plan.

[zazeez]

Thanks for sharing the correlations.
On economic policy, I'll choose free market laissez-a-faire over Keynesian central planning any day of the week. See Hazlit's 'Economics In One Lession', or Austrian Business Cycle Theory for more details on the secondary effects and net effects of government spending to 'manage' the economy.

[Alan Longbon]

@zazeez

Hello and thanks for reading and commenting.

It looks as if you hold some very orthodox neoliberal economic views which is not surprising given the high level of mainstream coverage. Mainstream myths such as the following:

The big financial myths is a group of myths that deny monetary sovereignty. Within that group of myths are such statements as:

1. Federal finances are like your personal finances.
2. Federal taxes and bonds fund federal spending.
3. The federal deficit and debt are unsustainable. seekingalpha.com/...
4. Federal spending causes inflation.
5. The federal government can run short of its own sovereign dollars.

Each of these statements is false in a modern fiat money economy. People believe these myths because:

1. Trusted sources like the media, the politicians, and many economists promulgate the myths.
2. The myths equate national financing with people's own personal financial experience, the myths sound reasonable.
3. People want to believe myths because it justifies their desire to cut benefits to those who are poorer.
4. The incessant, unrelenting repetition of the myths.
5. The myths are based on financial practice and regulations that were developed under commodity money (gold) and fixed exchange rate systems that no longer apply though still permeate educational and government institutions.
6. The myths do apply to the euro countries who are users of the euro and not its creator and thus are still on a commodity-based monetary system.

The myths are harmful because:

1. They vindicate widening the gap between the rich and the poor.
2. Justify reductions in federal spending for the public purpose such as healthcare, education and infrastructure and other benefits for the "not-rich."
3. Condone the easing of federal regulations meant to stop irresponsible bank lending.
4. Rationalizes the reduction in budgets for food, drug, and environmental protection.
5. Reduces federal spending that would otherwise grow the economy.

GDP = Federal Spending + Non federal Spending + Net Exports

Only one of these entities can legally create new permanent dollars and that is the Federal government, the other entities simply pass them around between each other.

GDP = GDI

The Federal Government Deficit = Private Sector Surplus, these are accounting identities true by definition.

Thanks again.

[EK1949]

Some debt cancellation might help, but I think credit conditions are most usefully addressed through the fiscal balances and more public investment. I oppose the Big Number theory that says the private sector suffers from nominal indebtedness. It suffers from lack of credit support from the public sector. Policy was "not enough is too much".

Income should be low to save dollars, so let's not create those dollars. And by all means run public investment as low as possible for as long as possible. It's not accidental that infrastructure neglect has gone on for so long. All you have to do is treat outcomes as expressions of the intention to produce them and you know what you need to know.

[EK1949]

Public investment is what private investment builds on. Trucks cross bridges, they don't blaze trails. CBs don't either. The lesson to learn is economic support beats market support.

From what I read here CBs withdraw their support and therefore woe is us, this is an investment site so we're all markety, yes? So how come I'm not on board? Why am I not woeful?

It's because the dismal results of targeting markets before the economy might lead to targeting the economy directly through investments in it. I say might, but in favor of this view is that even the terminally obtuse will finally say enough is enough, so as a last resort they'll accept investing in success and building to grow.

[Alan Longbon]

@EK1949 build to grow sounds good.

We won world wars with 25% deficit spending imagine what we could do in peacetime.

Debt deflation, austerity and collapse are thus the final stage of debt-ridden economies. This makes the “credit” or “financial” stage a transition to economic collapse and reversion to barter, unless political decisions from “outside” or “above” the market check rentier power to create a more stable and equitable social arrangement. That requires debt cancellations to bring an economy’s debt overhead back within the ability to be paid. Nearly all modern “stages of growth” theories deny the basic principle that defines “the final stage” of financialization: debts that cannot be paid, won’t be. Either a clean slate or a lapse into debt serfdom is needed to end the preceding cycle and inaugurate a new takeoff or recovery.

Hudson, Michael. J IS FOR JUNK ECONOMICS: A Guide To Reality In An Age Of Deception (Kindle Locations 5392-5399). ISLET/Verlag. Kindle Edition.

[Ralph Musgrave]

It's not at all obvious to me from the above charts how much of CB balance sheets are used to buy government debt and how much to buy PRIVATELY issued bonds and the like. There's a big difference. Buying government debt, i.e. QE is widely accepted as a justified stimulatory tool, thought it's not spectacularly effective. Buying PRIVATE stuff is a different kettle of fish: for example is it right to use taxpayers' money to enrich Wall Street rather than Main Street?

[Alan Longbon]

Hello @Ralph Musgrave

It is a grey area where it is hard to find answers and that is deliberately so.

Professor Steve Keen has done research that shows about half of the $4T spent by the Fed buying bonds and giving bank excess bank reserves was then used to buy other assets namely stock, bonds and FX. The Fed did not do it directly but the primary lenders did.

Professor Randall Wray has done work that shows the Fed lent out about $29T to keep banks afloat. Lent out never to be returned.

The Bank of Japan makes no secret of the fact that it buys both national gov debt and stocks by way of ETFs. Japan shows how the future will be for the rest of the developed world. They reached peak debt first and have been in stagnation ever since it took another generation for us to get there and now we have.

[EK1949]

""successful stimulus always tells you with great specificity how much it took" Hard to remember when that was the case but I hear what you're saying."

I take confirmation from both the positive and negative results. While you could claim that a failure of a program to reach a goal doesn't carry any information useful to a future successful program, the default position should be that no experiment is a failure unless you learn nothing from it.

In any case I'm quite deliberately not saying that a fiscal stimulus must succeed because it conforms to a dictionary definition of one. The retrospective "what it takes" aspect isn't a crafty dodge, it's an intrinsic feature of a dynamic system like an economy. I do insist that we learn as much from failures as successes.

[EK1949]

"I agree and think that was Keynes' intention but have read (by another SA writer) that any government stimulus is Keynesian."

That could be misleading. People will read it and interpret it as "government spending is Keynesian". Haven't we all heard the dreary argument as to how "the government spent a gazillion dollars, that proves stimulus doesn't work" which is a vastly dumb argument from nominal quantities and ignores that successful stimulus always tells you with great specificity how much it took, knowledge we can any time we want just by doing what we have to do.

[RAP77]

"successful stimulus always tells you with great specificity how much it took" Hard to remember when that was the case but I hear what you're saying.

[Alan Longbon]

These sort of CB decisions move markets.

This is pure sovereign currency creation in progress that lifts bond values and lowers yields.

Bondholders say thanks to Mr. Central Banker for looking after them for the unnecessary corporate welfare derived from:

1. Matching national government deficit spending with bonds sales. No need for this matching convention.
2. Maintaining the interest rate with a target rate instead of simply setting a support rate on reserves.

[EK1949]

"Isn't the recent Trump tax cut a form of Keynesian policy, especially when there's no indication yet that enough new business has been generated to pay for the $1.5T?"

Deficits are the pay for. Paying for what the economy needs is why you have them.

My own interpretation of a Keynesian tax cut is that it depends on both the size of the cut and how it falls on savings versus spending in the private sector.

Let's say you want the tax cut to be Keynesian, that is expansionary for the economy generally and specifically for jobs, wages etc. You'll choose cuts that boost spending more than savings of high earners. Let's say you don't want the Keynesian effects, you target people who save a high proportion of their income.

There's also the question of the other side of the fiscal balance, the spending side. Higher spending has stronger Keynesian effects than equivalent tax cutting. I note it's difficult to tax cut a bridge into existence.

Finding out how Keynesian present policy is requires consideration of both sides of net spending, spend side and tax side.

[RAP77]

"Higher spending has stronger Keynesian effects than equivalent tax cutting."

I agree and think that was Keynes' intention but have read (by another SA writer) that any government stimulus is Keynesian.

[RAP77]

"...and the others are likely to follow, there being no other choice outside of the taboo realm of national government Keynesian-style fiscal spending on first-class healthcare, education, and infrastructure."

I agree. Isn't the recent Trump tax cut a form of Keynesian policy, especially when there's no indication yet that enough new business has been generated to pay for the $1.5T? It seems to me the "taboo realm" you mentioned could be more effective in the long term.

[EK1949]

If I understand correctly the QT headwind will swallow the deficit tailwind.

"For these people, there is no alternative (TINA), and one could expect that one of the less publicised outcomes of the meeting was the need to keep buying. Japan has been doing it for decades, and the others are likely to follow, there being no other choice outside of the taboo realm of national government Keynesian-style fiscal spending on first-class healthcare, education and infrastructure."

I've said this for years, central bank "fiscal replacement therapy" is ineffective and unproductive to the point of being anti-productive. It's a refusal to spend the economy up by public investment. Net government investment which historically is between 1 and 2% is now around 0.5% and has fallen since '09. The principal means of producing higher gains in future cycles while boosting gains in the present one has fallen!

Whose plan is this? What's it for?

[KylerM]

Thank you Alan for another informative article!

[Alan Longbon]

Hello @KylerM thank you for reading and commenting.

[Denture Capital]

The popular word "Don't fight against the Fed." is true and better to broaden "Don't fight against the central banks!"

[Alan Longbon]

Hello @DorkVader yes very true. Do not fight the Feds.

[NotARetiree]

Interesting article on central bank effects on world markets. John Kicklighter from DailyFX has a dove to hawk chart he uses to predict central banks monetary policy in his trading videos I find very helpful. Given what has been going in Europe, hard to believe they can QT very much if at all. China just announced a large stimulus program which should benefit emerging markets.

[Alan Longbon]

Hello @HighYieldKing one can take such a chart furthrt and use it as a predictive model for the direction of the stock market.

Thank you for your comment.

[ArizonaLuke]

Sir,
Many thanks for another excellent article. I'm a novice in this area. Could you say a few words about how the Federal Reserve has moved the trillions of new dollars into the US economy? What is the process by which USD4+ trillion has entered the money supply?
Luke, an Arizona Cowboy

[Alan Longbon]

Hello @ArizonaLuke The method is that the commercial sell their bonds to the Fed in return for cash. An equal value exchange.

The cash is created by the Fed on its keyboard, it just marks up their bank accounts by entering in the new higher number.

The commercial bank then has the choice of what to do with the cash reserves it now holds. About $2T has stayed as cash reserves and earns 0.25% interest from the Fed, the other $2T has been loaned and invested in assets including stock and bonds and FX.

[ArizonaLuke]

Sir
Many thanks for the response.
One last question: do certain private banks create their own bonds and then sell them to the US Federal Reserve?

For example, could Goldman Sachs "manufacture" bonds which the Fed would purchase?

I understand the Fed's purchase of toxic mortgage backed securities; however, it's not clear to me what other "securities" the Fed is allowed to purchase.

all the best, ArizonaLuke

PS: in a more numerous vein: can I monetize my cattle? ... and issue bonds called "Cow Patties" and then sell these bonds to the Feds? ... I could do a lot on the Farm with extra cash. LOL

[IamTheWolf]

If I understand FRB Balance Sheet runoff, the quarterly amount increases in July by $6B to $24B for Treasury holdings.

Looking at maturities I see:
July 31, 2018 -> $28B
August 15, 2018 -> $23B
August 31, 2018 -> $21B
I wouldn't expect it all to runoff, but certainly what has been announced/planned.

Question is: How immediate is the impact to those reductions? That's $48B out somewhere in the next 30+ days.

[Alan Longbon]

Hello and thanks for reading and commenting @IamTheWolf

There is generally a lag measured in quarters between CB bank balances and asset markets.

One way of estimating it is to take the charts above and move the stock market line until it best fits the CB line by moving it to the left. That will give you an idea of the lag.

[jyard01]

"QE has never occurred before on a global scale. QT has never occurred before." In fact the precedent for QE occured during WWII, when the credit markets were nationalized to support war production. A QT like effect occured during the late 1940's , when credit markets were normalized.
It's correct to say there were substantial differences between today's economy and the 1940's , but QT happened without automatic catastrophe . It is not without precedent .

[Alan Longbon]

Hello @jyard01 thankyou for reading and commenting.

Yes that is a good point. WW1 would be another example of QE.

The big difference is that in those war periods it was not paper assets that were inflated but real assets were built.

In order to produce all those war goods (which are not very productive in themselves) a lot of production facilities were built which expanded the productive capital base and was a springboard for further production after the war for consumer goods.

It also created jobs in the factories, building the factories and fighting the wars.

Which is going on now, paper asset inflation is the opposite of those things. No jobs, no productive asset expansion, no additional income from which to buy production. Just rich people getting richer in nominal terms at the expense of the advancement of the public purpose.

[jyard01]

agree

[User 871400]

Great article. Seems to me there is a trade here as long as ECB doesn't pull off the buying - go long Germany, go short Italy or Spain (Italy if you insert politics here:)).

[Alan Longbon]

Definitely worth buying German DAX dips and then selling the rallies. Have been doing a bit of that myself.