Ballooning debt will force the Federal Reserve to bring back quantitative easing, Michael Howell wrote.
He said in the Financial Times that the Fed’s balance sheet will have to double.
“Investors should therefore expect a continuing tail wind from global liquidity instead of last year’s severe headwinds.”
Ballooning debt in the coming years will force the Federal Reserve to buy massive amounts of bonds again, according to Michael Howell, managing director at Crossborder Capital.
Writing in The Financial Times on Wednesday, he predicted that the central bank will have to abandon its quantitative tightening plan, which would roll back prior stimulus by shrinking the Fed’s balance sheet. Instead, the Fed will return to its quantitative easing scheme, lifting stocks in the process, he added.
“Investors should therefore expect a continuing tailwind from global liquidity instead of last year’s severe headwinds. This should prove good for stocks, but less positive for bond investors,” Howell said.
Despite forecasts of a looming funding drain, the liquidity cycle has already passed its bottom and will trend up over the coming years, he said.
Howell noted that the Fed and other central banks earlier this year plowed liquidity into the global financial system during this spring’s banking turmoil, which was caused by the collapse of Silicon Valley Bank.
“But in coming years they will probably have to bailout debt-burdened governments, too,” he warned.
According to Howell, about seven in every eight dollars churning through global markets are already used for debt refinancing. And of the remaining dollar, a growing portion is going toward expanding government deficits.
That’s as developed economies are being faced with fresh pressure to expand public spending, as a renewed focus on military requirements and changing demographics weigh on budgets, he explained.
“In a world of excessive debt, large central bank balance sheets are a necessity. So, forget QT, quantitative easing is coming back. The pool of global liquidity — which we estimate to be about $170 trillion — is not going to shrink significantly any time soon,” he wrote.
According to Congressional Budget Office estimates cited by Howell, the Fed’s Treasury holdings would have to rise to $7.5 trillion by 2033 from nearly $5 trillion today.
But he thinks that forecast is too low.
“More realistic numbers point to required Fed Treasury holdings of at least $10 trillion. That translates pro rata into a doubling of its current $8.5 trillion balance sheet size and will mean several years of double-digit growth in Fed liquidity,” he wrote.
Few alternatives to QE exist. Governments are locked into certain mandatory spending requirements, such as entitlement spending, and existing tax bases can’t be squeezed much further, Howell added.
Meanwhile, geopolitical tensions will likely reduce China’s demand for US debt. At the same time, US households and pension funds will demand higher interest rates, worsening the deficits and the debt problem, he said.
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