Global Balance Sheet Expansion: Who Really Moves Markets?

Since late 2008, the world’s central banks have been in a race against time. They have expanded their balance sheets wildly, purchasing a total of $10.5 trillion dollars worth of assets in an attempt to stabilize markets. This has inflated bubbles in both equities and the bond market. As we reported previously, the level of the Federal Reserves total assets explains 93% of the variance in the S&P 500 index.

Today we take a more detailed look at the balance sheets of the Fed, Bank of England (BOE), European Central Bank (ECB), and Bank of Japan (BOJ). Together they hold over $16 trillion dollars worth of assets on their balance sheets. Much of this has been used to purchase government debt.

The following is a matrix showing how correlated various central bank balance sheets are with each other, as well as four global stock indices: the S&P 500, DAX, FTSE 100, and Nikkei 225.

sources: FRED, BOE, ECB

sources: FRED, BOE, ECB

As we can see, the ECB is off in its own planet. Its balance sheet has the lowest average correlation with both other central banks as well as asset markets. Put simply, the ECB’s balance expansion had little effect on asset prices; they have not coordinated their monetary easing operations with other banks. 

Moreover, their expansion was the weakest of any major central bank, purchasing only $729 billion worth of assets, versus $3.5 trillion and $4.8 trillion for the Fed and BOE, respectively. They started out on the same trajectory as the Fed, even overtaking it for a brief moment in 2011. Then the ECB took their foot off the gas; now they are trying to restart a stalled economic engine.

central bank total assetsThe clear winner in terms of overall market clout is the Federal Reserve. Its will be done. Markets have the highest correlations with the total size of the Federal Reserves balance sheet. Both the DAX and the S&P 500 indices have over 90% correlations with total assets.

Federal Reserve Total Assets vs S&P 500 Stock Index

The Bank of Japan engaged in monetary policy most similar to that of the Federal Reserve. The Nikkei 225 has a high correlation with the level of BOJ asset purchases. The BOE was the most aggressive in their quantitative easing, but failed to influence asset prices to the same degree as the BOJ and the Fed.

6 replies »

  1. Hi, pardon my ignorance, but I have a few questions.

    1. The Central bank’s policy is to stimulate growth and not the equity markets if i’m right. In this scenario, wouldn’t it be that the BoE’s policy was the safest and that the chances of FTSE crashing when Boe offloads its asset purchases would have a more limited impact than compared to the Fed v/s S&P?

    2. The ECB also, in this case might have missed the boat, but by doing so, isn’t there a better chance for stimulating growth rather than focusing on the DAX and other indices?


    • Each central bank has slightly different mandates, but basically each one has to maintain price and economic stability to some degree. The Fed is unique because it must also achieve maximum employment.

      With each bank presented with such broad mandates, it is up to the people that run the central banks to determine how best to implement these objectives. QE-based easing has focused on using the bond and MBS market as its channels, directly buying trillions of dollars worth of debt. However, central bankers such as Ben Bernanke have hypothesized that a knock-on effect of QE would be to bolster equity prices. He considered this desirable, as the increased wealth from stock market gains would make individuals feel more confident, and thus be more likely to spend and invest.

      Other central bankers follow a similar train of thought, and use the stock market as an indicator of market sentiment, and a “legitimate” recession forecaster. Thus in attempting to achieve their stated mandates, they prop up equity markets as well as credit markets. Ever notice how any day a central bank is easing, BOTH equities and bonds are up?

      in reality we are all subject to a classic principal-agent problem. Every central banker knows the market is addicted to stimulus, but none of them wants to be the one the public blames for the crash. Remember, people only spend a few years as a governor of a central bank; they have careers to think about. If they’re holding the bag when the market crashes, they might not get lucrative private sector jobs or speaking tours. Bernanke was smart, getting the fuck out and passing the hot potato to yellen.

      These central bankers, however, only carry reputation risk. The actual principal risk is born by the taxpayers. Think of the amount of money spent acquiring assets as public risk — if things go badly the public will lose the money invested. Thus we can look at the amount of wealth created as the reward, and get a general idea of the ROI, so to speak. Thus we can look at what the BOE did as overkill for its constituents: the people of the UK. rather, they stimulated so much because 1) London is a huge financial center and they didn’t want to fuck that up and 2) the BOE used to be the main lender of last resort from 1700-1900, and britain has collective neurosis with losing global power. What better opportunity to prove your relevance than buying more assets than anyone else?

      As for Europe, you might be correct in that they have more ammunition to wield. HOWEVER, there is a reason they have yet to wield it. If it is a choice from the ECB then that is the case; if the market heads south they can do QE proper. But if the reason is the Germans won’t let them, thats a far different story. Germany is obsessed with austerity, and won’t mind bringing down the whole eurozone to avoid hyperinflation (collective memory of Wiemar republic)

      Liked by 1 person

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