Central Banks Tightening From All Sides

Balance sheets to shrink

Central bank balance sheets, 2007-2022

Rate hikes have consumed the market’s attention this year. And rightly so. Central banks are taking a “whatever it takes” approach to pushing inflation back down to their targets, in our view. Just last week, the European Central Bank (ECB) raised rates another 0.75%. Markets expect the Fed to do the same this week. That’s a record pace for the ECB – one it’s signaled may slow – and the fastest hiking cycle for the Fed since the 1980s. Most major central banks aren’t fully acknowledging that hiking enough to tame inflation will cause recessions, as we see it. There’s another specter looming over markets: balance sheet reductions, or quantitative tightening (QT). Balance sheets have already started to dip this year. See the chart. Central banks selling or ceasing to buy government bonds could increase the risk of financial dislocations from yield spikes sparking risk asset selloffs.