- As global economies recover, central banks are shifting towards ‘normalising’ their bloated balance sheets. Given the scale of the previous build-up, many investors fear that this could be hugely disruptive to markets.
- Yet, this is unlikely. The Fed’s balance sheet is unlikely to return to its pre-crisis size and the path towards its steady-state size is likely to be a gradual one. The move is well anticipated by market participants and the Fed can use both rates and its balance sheet size to calibrate overall monetary conditions.
- What is more, normalisation will (only) take place against a backdrop of economic recovery and the Fed will deliberately choose to remain “behind the curve” (i.e. tolerate an overshoot of the inflation target).
- On a positive note, the release of collateral into the market is set to expand private sector balance sheets and lubricate the financial system.
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