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Why All The Fuss About Central Bank Balance Sheets?

A central bank’s balance sheet allows you to see how much stimulus the central bank has added over time and how it’s influenced financial markets. ---- We interpret and explain price moves in real-time, 24 hours a day. Our team of analysts produce text, video and audio commentary. You understand the markets and trade with confidence. Learn more at our website here: https://financialsource.co ----- We have a quick question from Niroshan who asks what is the importance of Central Bank Balance Sheets and how can we use it in our trading? Thanks for the question Niroshan. The main focus on CB balance sheets actually has more to do with Quantitative easing than the actual breakdown of each bank’s balance sheet. With the onset of the Global Financial Crisis, central banks like the ECB and Federal Reserve put in motion non-conventional policy tools like Quantitative Easing because cutting interest rates just wasn’t enough to stimulate growth in the economy and assure markets that rates will stay lower for longer. With quantitative easing the idea was to buy billions of MBS and Treasury bonds from commercial banks which would drastically increase the commercial bank’s excess reserves which theoretically should allow banks more flexibility to lend out the money to will borrowers and so doing spur economic growth. Now apart from increasing bank reserves to stimulate borrowing, QE also has other uses by the bank, one of which is to artificially keep bond yields low, especially at the back end of the curve, as treasuries are used as a baseline for most long-term interest rates it’s in the FED’s interest to keep them low to give borrowers (whether companies or individuals) assurance that rates will stay low for a long time which should encourage them to take out loans to invest in their companies or buy a house etc. Apart from that, if the central bank manages to lower the value of their currency by increasing the money supply, theoretically the lower currency the higher the odds of inflation, but central banks are yet to see inflation increases realise from the use of QE. So, if we take a look at the FED’s balance sheet on tradingview, by the way we did a video a while back about a website called quandl and how their charts can be used on Tradingview, so make sure to check that out, the way that I got this chart was by just typing in quandl and Fed balance sheet, and then choose the first one called “all federal reserve banks: total assets”, when this opens up it will give you this chart, and to use this in tradingview you’ll see a code on the top right of the quandl page, so you simply copy this code, go over to your tradingview chart, in the search bar type in the name quandl followed by a colon and then paste in that code you copied and simply press enter. That will give you the fed’s balance sheet. So, the focus on the balance sheet isn’t the same as doing a bottom up analysis of a company’s balance sheet if you want to trade it’s stock for example, the focus on central bank balance sheets revolves around the amount of stimulus they are adding to support the economy. If you look at the Fed’s balance sheet and you overlay that with the S&P500 and the Nasdaq you can see as the balance sheet has expanded, it has been supportive of the stock market. You can see the moment the FED stepped in with their unlimited QE program in March, it provided a floor for equities to storm higher, and the FED even expanded their purchases to include certain ETF’s that allowed them to buy company bonds, which added further stimulus to the stock market. For a lot of market participants this chart is a scary one, because if the FED should suddenly stop the gravy train and taper, what will that mean for the stock market as it would mean much tighter financial conditions and won’t be propping up so called zombie companies anymore. So, to answer your question in terms of trading, this isn’t really a chart that we would watch every day, as the focus isn’t so much on the balance sheet but on what is happening with QE. Where it does get interesting though is where we see purchases starting to slow or starting to increase, as that will not go unnoticed and can have pass through effects into risk assets. But overall, the main focus for the balance sheet revolves around the QE and QT, if that makes sense. So, hope that answers your question Niroshan, any other questions just let us know. ----- If you find this content helpful, you’ll love Financial Source. There’s a link below were you can learn more about it https://financialsource.co