In an earlier post, I added reserve purchases by the world’s major emerging market central banks, Japan and Switzerland to the bonds purchases by the Fed, the BoJ, the ECB and Bank of England. I wanted to highlight that the central banks of the world were buying a lot of U.S. and European bonds before the big central banks started quantitative easing (QE). China and others bought a ton of bonds prior to the global crisis.
Emma Smith, an analyst at the Council on Foreign Relations, helped me with the data work for that post; she and I are jointly writing the follow up posts.
In addition to looking at the total number of G-4 bonds bought by the world’s central banks—counting bonds bought in large scale asset purchase programs (QE) alongside estimated reserve purchases—it is interesting to look at central bank purchases by currency. QE results in the purchase of your own country’s bonds; reserve purchases mean you need to invest in bonds issued by someone else—e.g. both the Fed and the PBOC have bought large quantities of U.S. Treasuries and Agencies at different times over the last fifteen years.
Take central bank purchases of dollar bonds. The chart below relies on the Fed’s data on its purchases, and an estimate of the dollar bond purchases implied by global reserve growth.
Before the global crisis, central bank purchases of dollar bonds came from reserve managers. Their accumulation of dollar assets picked up from around 2003—coinciding with the dollar’s depreciation against the euro, the beginning of the rise in China’s current account surplus and a pickup in capital flows to a range of emerging economies. In early 2008, the Fed was actually selling a portion of its bond portfolio—it didn’t want its balance sheet to expand as its lending to the world’s banks rose in the run-up to the global crisis—and after Lehman, reserve managers started to sell. But the Fed soon reversed course, and started purchasing large amounts of Treasuries and Agencies in its QE programs. And emerging economies recovered and resumed large scale intervention of their own—albeit at a lower level than pre-crisis—taking central bank demand to new highs.
Post QE3, though, central banks’ direct purchases of dollar bonds collapsed. The Fed stopped buying, and emerging market central banks have on net been selling. The current (low) yields on ten-year Treasuries aren’t a function of a direct central bank bid.
The story for euro and yen bonds though is almost the opposite of the story for dollar bonds. Purchases by reserve managers were never as important, and in the past few years, both the ECB and the BoJ have ramped up their direct purchases.
Before the global crisis, reserve demand for euro-denominated bonds was around a third of the level of demand for U.S. dollar-denominated bonds. Reserve purchases of euros continued through 2012, and any slowdown in their demand was made up for by the ECB’s initial purchases of bonds (through the SMP).
There was a drought in total central bank purchases from 2012 to 2014 (part of the reason why the euro stayed high?).
And then, obviously, a spike associated with the ECB’s QE program. The scale of the ECB’s purchases far exceeds the estimated scale of euro-denominated bond purchases by the world’s reserve managers. Net central bank demand for euro assets thus is at a long-term high.
Yen and sterling-denominated assets have never played all that large a role in reserve managers’ portfolios.
For the yen in particular, central bank demand for bonds has essentially come from the Bank of Japan.
And I should note that the estimated central bank reserve purchases are just that—estimates. Much of the flow comes from an assumption that central banks that do not report the currency composition of their reserves (at least not historically) to the IMF have maintained a constant yen share of their reserves. With the yen’s fall from 2012 to 2015, that required some purchases…
Reserve managers were more interested in the pound pre-crisis. Actually until fairly recently! But the scale of reserve inflows was still dwarfed by the Bank of England’s asset purchases in 2009-10 and 2011-12. (Note the scale has changed from previous graphs.)
While central bank purchases of sterling disappeared in the past few years, they obviously are now poised to pick up. After the Brexit vote, the Bank of England announced £70 billion ($90 billion) of gilt and corporate bond purchases.
Is there a big story here? I suspect so, but it is also a complex story—and a more complex story that I think is widely recognized.
A few points.
The data here shows the flow of central bank purchases, not the stock. The stock of bonds held by central banks may matter more for rates. And that stock is going up everywhere but for the United States. And while there isn’t a central bank bid for U.S. dollar bonds right now, the stock held by reserve managers and the Fed isn’t going down that much, as the Fed is keeping its holdings constant.
U.S. yields are also a function of the market’s expected course for the Fed. And by the echo of the central bank bid outside the United States.
In a subsequent post Emma and I will show that the BoJ and the ECB’s purchases far exceed issuance (something that wasn’t true for the US at the peak of “QE”), so the BoJ and ECB are reducing the stock of bonds in the market’s hands. Some of that feeds into demand for other assets in Japan and Europe, some of it feeds into demand for U.S. bonds.
That is what the TIC data in the U.S. is also telling us. Central banks—reserve managers—are selling U.S. bonds. The net inflow that supports the U.S. current account deficit is a function of Americans who previously held European and Japanese bonds selling and bring the proceeds home (and who prefer the yield on Treasuries to the yield on bunds and JGBs) and purchases of U.S. bonds by private investors in Japan and Europe.
Think of low rates in Europe and Japan as a requirement, in equilibrium, for European and Japanese savings to leave their home regions and take currency risk abroad.
It all adds up, as it must. But it is a slightly different equilibrium than the equilibrium in the pre-crisis world, where emerging market central banks took on a lot of the world’s cross-border currency risk. Their large scale reserve purchases were a function of both their underlying current account surpluses and net private inflows, as investors were moving money into fast growing emerging economies. Today a lot more of the currency risk associated with the United States ongoing need for financing (the U.S. still runs a current account deficit) is being taken on by private investors.
All this said, our goal here is not to put out a fully formed theory—we don’t have one. Our goal is simply to illustrate how to combine the reserves data with data the major central banks report about their own balance sheets. Of course the implicit argument is that the “market distortions” from “QE” likely preceded “QE”, as there isn’t a strong theoretical reason why PBOC purchases that remove U.S. bonds from private market hands have a widely different impact than Fed purchases that do the same thing (abstracting from any signaling about the course of U.S. rates in the Fed’s purchases, of course).