When standard interest rates aren’t enough, central banks use their balance sheet as a secondary lever to inject or drain market liquidity: Quantitative Easing (QE) - the ECB buys government bonds to flood the system with cash, pushing bond yields down and supporting asset prices. Quantitative Tightening (QT) - the ECB sells bonds or lets them mature, draining cash from the system and leaving investors to absorb the extra bond supply.
CURRENT READINGS
The ECB currently holds EUR 3.5trn in financial assets on its balance sheet. It just removed 5.0bn EUR liquidity from markets last week by selling/letting mature bonds it owned. In light of this, net bond supply available to investors remains positive but has started to trend down. EU bond yields are not supported by quantitative operations.
MARKET IMPLICATIONS
The falling balance sheet of the ECB shows a 1-year correlation of -0.85 (strong) with rising 10Y German bond yields and of -0.88 with rising stocks in the Stoxx 600 index (this is a strong negative correlation between the ECB balance sheets and stocks moving in different directions, implying no causation here as stocks are moving for different reasons). This means that ongoing quantitative operations had NO CAUSAL INFLUENCE influence stock prices and had MAJOR INFLUENCE influence bond yields.
This is the Quick Playbook on Central Banks' Balance Sheets: when the ECB runs QE (Buying), it floods the system with cash and vacuums up bonds. This drives bond prices up and yields down, effectively flooring borrowing costs to stimulate the economy.
When the ECB runs QT (Selling/Maturing), it drains cash from the system and leaves extra bonds on the market. This pushes bond prices down and yields up, raising borrowing costs to cool things off.