The Week’s Global Economic Events: What It Means for Central Banks to Cut down Debt

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In here, we take a look at global economic updates or interesting key developments that investors can take note of. This week brings me to Central Banks’ curtailment of debt holdings and what may happen as a result.

Central Banks getting prepared to cut debt holdings

As the United States Federal Reserve prepares to end its bond buying program by the third quarter this year, other central banks around the world are cutting their own exposure to long-term debt to protect themselves from the potential risk of rising yields (yields rise when the price of debt falls).

The Financial Times recently reported on a survey of reserve managers of central banks that hold almost US$6.7 trillion in assets (a figure worth more than half the reserves of central banks) and they said that they were going to adjust their portfolios in order to prepare themselves for a stricter monetary policy in the future. And by adjusting, those central banks actually mean that they’re starting to shift into other financial assets like equities (which are generally thought of as being riskier), or simply cutting the maturity of their loan portfolio.

With the US and UK trying to bring interest rates back up to more normal levels in addition to big portfolio changes in other central banks, the Financial Times warned of larger “risks of market disruption” in the same survey-article.

What it means for the retail investor

Although the health of the U.S. economy, in many ways, may still be far off from its boom era peak, the American share market has certainly been on a blast with the S&P 500 (a broad American market index) having gained close to 160% since its bottom in March 2009.

For investors worried about the American economy’s health, there’s also been some good news. Bloomberg had recently given snippets of a press conference that new Fed Chair Janet Yellen had held on 19 June. She said, “Economic activity is rebounding in the current quarter and will continue to expand at a moderate pace.”

Moving forward, interest rates may be poised to normalize – with the Federal Reserve continuinng to taper its bond buying programme on the back of an improving American economy – and turn higher after years of being weighed down due to government policies in place.

While companies in need of borrowings and debt may have to grapple with higher interest costs, banks such as DBS Group Holdings (SGX: D05) and Oversea-Chinese Banking Corporation (SGX: O39) may be the ones grinning from ear to ear; banks stand to earn high profit in a higher interest rate environment.

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