Chinese State Media Warns of Risk Surrounding US Fed’s Shrinking Balance Sheet

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An editorial piece published by the Chinese government’s Xinhua News Agency warns of the perils that could attend any further balance sheet contractions by the US Federal Reserve.

Published just following the close of China’s National Finance Work Meeting, where policymakers emphasised the “perennial” importance of preventing systemic financial risk, the editorial notes that the US Federal Reserve is expected to raise rates a third time in December, following its second hike for 2017 in June.

According to the Xinhua editorial the current cycle of US Fed hikes is a “slow braking” in terms of pace, with small and steady increases in rates, while market expectations have been quite adequately managed, without any unexpected policy moves.

Xinhua sees the the Federal Reserve’s balance sheet contractions, however, as posing a significant source of new risk, following the central bank’s public announcement of a reduction in assets at the same time as the rate hike in June.

“Following the 2008 Financial Crisis, the US Federal Reserve has undergone three successive rounds of quantitative easing (QE), purchasing large volumes of US Treasuries and institutional mortgage backed securities.

“The scale of its balance sheet has expanded from $USD1 trillion prior to the crisis to $4.5 trillion at present.

“Balance sheet contractions can be considered counter-operations to QE, and their impact upon the US economy as well as the spill-over impact on the global economy are hard to overlook.

“The key to the US Fed’s shrinking of its balance sheet lies in avoiding lost of control of long-term interest rate levels. If long-term interest rates surge, this will harm the recovery of the US economy, and spillover effects could lead to turmoil in global markets, as well as trigger risk and crisis.”

Another potential source of risk discerned by the Xinhua editorial is shifting trends in the monetary policies of major economies or issuers of reserve currencies, such as the EU, UK and Japan.

“Many analysts and investors are concerned that the era of historically low global interest rates and unprecedented purchases of sovereign debt by central banks is rapidly coming to an end.

“The European central bank has just indicated that it will maintain loose policy, but has ruled out the possibility of further rate cuts, believe the risk of deflation within the Eurozone to be over.

“This indicates that it is already cautiously considering how to withdraw from stimulus policies in future.”

Xinhua further points out that both the Bank of England and the Japanese central bank have public indicated that they are mulling withdrawal from loose monetary policy within the next several years.

“More and more analysts and investors predict 2018 will become the year that the tide of loose monetary policy around the world finally ebbs. Central banks around the world have played the role of ‘superhero’ during the current market cycle, but this role must at some point eventually come to an end.”

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