Correlation vs. Causation

Investors,

Global central bank balance sheets have hit their lowest levels since September 2020, highlighting how the unwinding of monetary stimulus continues to persist. By combining the total assets (in USD terms) for the following central banks, we can measure the aggregate size of their balance sheets:

• The Federal Reserve

• The European Central Bank (ECB)

• The Bank of Japan (BOJ)

• The People’s Bank of China (PBOC)

As of the latest week, these central banks are holding $26.664Tn in total assets.

I decided to measure the 1, 2, 3, and 4-year moving average of the data:

For the first time in the history of the data series, their combined assets have fallen below their 4-year average. We can also see a decisive downward slope in their 1 & 2-year trends, while the 3-year average flattens out. It’s worth noting that the 4-year trend is still aggressively rising, influenced heavily by the monetary bazooka that was launched in 2020 through mid-2022. Given the consistent nature of monetary tightening for the past 18 months, we should assume that the 4-year trend will start to reflect the downward momentum in the nominal data.

Why is that important?

Because there’s a fairly clear relationship between central bank-induced liquidity and stock market prices (using the S&P 500), as shown by the chart below: