Central banks are planning to cut their exposure to longer-term debt to protect themselves from losses when the Federal Reserve ends its bond-buying this autumn, increasing the risk of instability in global markets

June 23, 2014 12:01 am

Central banks set to cut debt holdings

By Claire Jones in Frankfurt

Central banks are planning to cut their exposure to longer-term debt to protect themselves from losses when the Federal Reserve ends its bond-buying this autumn, increasing the risk of instability in global markets.

The majority of respondents in a survey of reserve managers who control assets worth $6.7tn, or more than half of central banks’ total reserves, said they were likely to adjust their portfolios in preparation of tighter monetary policy.

As the UK and US embark down the path back to more normal interest rates, big changes in asset holdings by other central banks around the world would heighten the risks of market disruption.

The survey of 69 central bank reserve managers, polled in May by Central Banking Publications and HSBC, suggested many have already started to move into riskier assets, such as equities. That trend looks set to continue, with just under half of those polled saying they could envisage buying shares or exchange traded funds. Others said they would cut the duration of their bond portfolios.

As the global economy shows some signs of returning to health, the Fed and other advanced economy central banks, such as the Bank of England, have started to consider tightening monetary policy. The prospect of higher interest rates have raised fears that a 30-year bond market rally is drawing to a close and that prices will fall in the years ahead.

While mass bond buying through quantitative easing and cuts in interest rates to record low levels have been credited with staving off another Great Depression, other central banks will be among the biggest losers from the return to normal because many have invested heavily in advanced economy government debt.

The Fed has bought almost $2tn in US government debt for the past six years as part of its quantitative easing programme, but is set to stop in the autumn after phasing out its bond-buying. When that happens, the price of US Treasuries, which moves in the opposite direction to yields, is likely to fall.

While the Fed is the biggest holder of its government debt, it is closely followed by other central banks, which invest a significant slice of their $11.7tn reserves stockpile in the sovereign bonds of the world’s largest economy.

As conservative and secretive asset managers, they have traditionally invested heavily in US Treasuries because the size of the market – the largest and most liquid in the world – gives them quick access to dollars they can sell to stabilise foreign-exchange markets.

But the reserve managers also said their central banks were considering diversifying their currency investments.

At the end of last year, more than 62 per cent of central banks’ investments were held in dollar-denominated assets, according to the International Monetary Fund, while just short of a quarter were in euros. However, higher-yielding currencies such as Australian and Canadian dollars, as well as the renminbi, had become more attractive because of the lower returns on US Treasuries.

The shift into equites has pushed stock markets to fresh highs. Since early 2009, the MSCI world developed markets index, used as a benchmark by the Dutch central bank, has risen 150 per cent. The US S&P 500 has risen by 190 per cent.