The possible strategies ahead; passive behaviour and small initial moves
In any case, there is agreement of views among the various speakers who have alternated in recent days: the QT on securities will be very gradual, even slow in the start-up phase.The historical experiences of reducing balance sheet assets are few and characterized by various types of problems: the Federal Reserve (FED) made an attempt between 2017 and 2019, using a passive type technique; in other words, it did not reinvest maturing government and securitized mortgage backed securities. An active strategy would have envisaged the sale on the secondary market of assets with a significant residual life.After about 2 years and a contraction in assets of about 15%, the Fed had to abruptly interrupt its operations due to growing problems of access to liquidity for small banks on the money market and was forced to launch a semi-permanent support facility. Simultaneously, the FED stopped raising interest rates, abruptly ending the cycle of restrictive policy.
The FED has been trying again since May 2022: the pace of liquidity reduction is significantly higher and the fear that problems on the money market could quickly reappear is high. Also in the United Kingdom, the QT strategy just presented by the Bank of England (BOE) was postponed due to a crisis of confidence in the secondary market for government bonds, dangerously extending to pension funds, which forced a restart – albeit temporary – of purchases of government bonds.
Therefore, even in the radical vision of the president of BuBa, the QT on bonds would be characterized by a passive type strategy, further limited by the reinvestment of a significant percentage of maturing securities. The pool of securities concerned would only be that pertaining to the older Asset Purchase Programs (APPs), launched by the ECB between 2015 and 2016, amounting to around €2,750 billion. The € 1.8 trillion mainly government bonds purchased between March 2020 and March 2022 under the Pandemic Emergency Purchase Program (PEPP) would instead be exempt until at least December 2024.In order to understand what could be a reasonable path to reduce the balance sheet over the next 26 months and evaluate its possible impact on the markets, references to public statements of the ECB board have been taken into account. The start of a QT in January 2023 was therefore assumed, which would impact 50% of maturing securities, which are currently fully reinvested by the ECB. Only in 2024 is it assumed that the percentage of non-reinvested securities will rise to 100%.
Using these parameters in the simulation, in 2023 the stock of bonds in the ECB portfolio would contract by approximately €180 billion, which would rise to €310 billion in 2024. BTPs maturing in 2023 correspond to €30 billion, €50 billion in 2024, in total about € 80 billion which would not be reinvested in equivalent securities. At first glance, the situation appears to have little impact: if we consider that the ECB holds €773 billion of Italian government bonds, the reduction should only concern 10% of the stock over the next two years.
If the principal buyer of government debt disappears, what happens?
However, unlike the equivalent programs performed by the FED and the BOE, the ECB’s QE was more complex because it involved heterogeneous securities, in terms of creditworthiness, market depth and demand structure. Consider the evolution of the monthly variations of the Italian and Spanish public debt broken down by holder, to understand the structural characteristics of the demand for the so-called “peripheral securities” of the Euro area.