Withdrawal of central banks from bond markets
Analysts: trillion-dollar portfolios being wound down
Ibrahim Al-TarikMay 8, 2025
The biggest buyers in bond markets are now becoming sellers as central banks, which have bought trillions of dollars worth of bonds since the 2008 financial crisis, begin to wind down their huge portfolios.
Leading central banks such as the U.S. Federal Reserve and the Bank of England are widely expected to begin the process of "quantitative tightening" in the coming months, complicating the outlook for bond investors who are already grappling with runaway inflation and the specter of aggressive rate hikes this year.
The looming tightening of monetary policy stands in stark contrast to the corona virus measures implemented in early 2020, when central banks around the world cut borrowing costs to historic lows and launched the kind of large-scale asset purchase programs used a decade earlier to stem the global financial crisis.
"Central bank balance sheets will shrink overall for the first time in history," said Ralf Preusser, global head of interest rate research at Bank of America. "Some central banks might also experiment with [active bond sales], which we don't have experience with either."
The BoE kicked off QT earlier this month by saying it would begin gradually reducing the £895 billion of debt it has bought over the past 13 years by stopping reinvestment of government bonds it holds as they mature and shedding £20 billion worth of corporate debt. If interest rates rise to 1% from the current 0.5% - which markets expect to happen as early as May - the U.K. central bank will also consider actively selling government bonds.
The Federal Reserve is likely to begin the QT process later this year, according to investors. It could provide more details on plans to reduce its $9 billion balance sheet at its meeting next month, when it is expected to raise interest rates for the first time since the pandemic began.
Now that employment and growth are picking up, a reduction in the Fed's balance sheet would allow it to roll back some of the measures put in place in early 2020 to support the U.S. economy.
Such a prospect comes as markets are now pricing in more than six U.S. rate hikes by the end of this year, with traders betting that the Fed will act decisively to stem rising inflation.
Another key source of bond demand will dry up as the European Central Bank is expected to phase out its own bond purchases later this year - although the ECB's QT is still thought to be some way off.
While expectations of rapid rate hikes by the Fed and BoE have roiled markets in recent months, bonds appear to have largely absorbed the idea of QT. Longer-term bonds, which are widely believed to have benefited the most from quantitative easing programs, have sold off far less than short-term bonds, which are closely aligned with interest rate expectations.
Some market participants see this as a sign that bond markets are remarkably relaxed about the prospect of central banks pulling back.
"Long-term bonds are practically living in cloud cuckoo land," said Craig Inches, head of interest rates at Royal London Asset Management. "Has the market priced in QT yet? No. People seem to be totally fixated on rate hikes and not thinking about balance sheets."
The Fed said at its January meeting that a significant reduction in its balance sheet would "probably be appropriate." In a set of "principles" laid out at the same meeting, the Fed said it would not begin reducing its balance sheet until after a rate hike, but otherwise has not commented on the timing of such a move.
The Fed has also said it could shrink its balance sheet more quickly than it did at its last QT after the 2008-09 financial crisis, when the Fed waited until 2017 to begin - about two years after its first rate hike.
For some investors, the bond markets' relaxed attitude toward the start of QT makes sense.
"If you look at the impact of QE, it wasn't so much that the central bank was buying bonds from the market, but the strong signal it sent that interest rates would stay low for a long time," said Salman Ahmed, global head of macro at Fidelity International. "The same goes for QT - you have to look at it in terms of what it tells us about interest rate policy."
Because the Fed has not indicated that reducing the balance sheet is an alternative to raising interest rates - it has repeatedly stressed that short-term rates remain its primary tool for containing inflation - markets assume the two measures are complementary, Ahmed said. "An early start of QT would be a signal that interest rates will rise faster," he said. "It is not seen as a substitute for interest rate policy unless central banks tell us it is.
Across the Atlantic, the U.K. could provide important clues about how markets react to rate hikes combined with QT. So far, the former seems to be having a far greater impact, with longer-dated bonds doing much better than short-term ones in this year's wave of selling.
"I'm sure the Fed will keep an eye on the UK. It's probably quite a useful control experiment," said Steven Major, HSBC's global head of fixed income research. "If you look at [the low long-term yields in the U.K.], there are a lot of willing buyers if the central bank just gets out of the way.
