The end of abundant liquidity
Most decisions on the withdrawal of central bank liquidity were made in 2022, but the effects are not expected to show until 2023. Even with central banks at various stages of the QT process, it is clear that their preference would go to a faster process. withdrawal of liquidity than that produced by a simple reduction in their bond portfolios.
In cases where some of this liquidity comes from policies other than QE, for example, in the case of the ECB’s Targeted Long-Term Refinancing Operation loans to banks, a faster withdrawal of liquidity consists of simply to create incentives for early repayment. The ECB has taken steps to this end at its October meeting and we expect around half of the €2.1 billion in TLTRO balances to be paid off by March 2023.
You would be hard pressed to show the effect of reduced liquidity in money markets in 2022. That will change
The Bank of England has an arduous task ahead. The basic principle is to introduce new facilities to absorb bank liquidity. This is in fact what the Fed’s reverse repo facility does in exchange for collateral. The BoE has yet to take such action, but repo rates and the reluctance of short gilt yields to fully reflect rate hikes could trigger calls for faster liquidity absorption.
Truth be told, you would be hard pressed to show the effect of shrinking liquidity on money markets in 2022. This will change in 2023. Irrespective of the currency area, the liquidity situation can still be described as abundant. This, in turn, led to lower money market rates. In the case of government bonds and pensions, these have moved further downwards from key rates. In the case of supposedly credit-sensitive money market rates, they failed to reflect rising systemic risk and impending recessions.