Central banks around the world are in the expansion mode as policymakers are implementing measures and financial stimuli to boost the economic activity marred by the Covid-19 pandemic. The aggregate balance sheet size of the major central banks including those of the USA, EU, Japan and China reached close to $23 trillion at the end of May 2020 compared with $10 trillion a decade ago. The balance sheet size of the US Federal Reserve rose by 72 per cent since the beginning of the year to $7.1 trillion on June 3, according to Bloomberg data.
Consequently, the global market capitalisation recovered more than 96 per cent of losses after the coronavirus became a worldwide pandemic in the second week of March. The US benchmark S&P 500 index has erased all its losses so far in 2020.
The data for the past fifteen years show a stronger positive correlation of 0.66-0.77 between the balance sheet expansion of central banks and developed equity market movements. Historically, Indian equities were an outlier among the EM peers with a high correlation of 0.79 with the US Fed balance sheet size given the country’s lesser reliance on exports for the economic growth and superior earnings trend.
But recently, this correlation has turned negative following the rising probability of a sharp drop in the country’s gross domestic product (GDP) as it observed more than two months of lockdown to stem the pandemic. A strict nationwide lockdown is expected to impact corporate earnings significantly for the current fiscal compared with the EM peers.
The DM equities have outpaced the EM returns so far in 2020. The latter reported outflows of $53 billion since the beginning of the year, according to the Institute of International Finance.
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