Central banks’ endgame: a new policy paradigm

“Investors will need to adjust to a paradigm shift away from the accommodative policy stance that has supported financial asset prices, to an environment that should make bonds more attractive while increasing the risk-adjusted required returns for other major asset classes.”


Major central banks in advanced economies are continuing the reduction of the large balance sheets acquired since the Great Financial Crisis (GFC). While the Covid-19 pandemic led to a significant acceleration in central bank asset purchases to address pandemic-related lockdowns and disruptions to economic activity, the unexpected rise in inflation has prompted central banks to tighten monetary policy, first by tapering their asset purchases, then primarily through higher interest rates. Now that the policy rate hiking cycle is over or almost over, at least in terms of market expectations, attention could turn to central banks’ balance sheet policies once more.

The Federal Reserve, European Central Bank and Bank of England have embarked on a path to normalise their balance sheets by reducing their asset holdings – primarily in the form of government debt. Investors therefore need to prepare for a shift towards more debt being financed by the market, especially as governments are still running large budget deficits.

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