New central bank harmony has markets changing their tune

LONDON (Reuters) - The world's top central bankers have delivered what seems to be a collective message this week that quantitative easing is being put back in its box and interest rates are going up - and global markets are taking note.

Until then at least, stock and bonds had again been trading higher on the premise that the total pot of global liquidity was still swelling despite rising Federal Reserve rates - courtesy of ongoing European Central Bank and Bank of Japan bond buying programs, most of all.

That's why Mario Draghi's apparent change of tack on Tuesday had such an impact on every global asset from Wall Street to London and Tokyo - far more than any of the latest Fed utterances.

German Bund yields , a proxy for core Europe's borrowing costs, doubled, spreads between U.S. debt and almost everywhere else tightened, and a number of big banks declared the dollar rally dead as the euro put it to the sword.

SEB investment management's head of asset allocation, Hans Peterson, said the central banks and their ultra-accommodative policies were "slowly, slowly, slowly turning".

"It remains to be seen how markets react longer-term," he added. "The thing is, we have a whole generation of investment managers and people in the markets that have never lived without central bank support."

Suddenly, the usual central bank noise has suddenly harmonized over what the Bank for International Settlements - where dozens of central bankers met at the weekend - called the "great unwinding" of easy money.

Hours after Draghi spoke, U.S. Federal Reserve chief Janet Yellen was warning of high asset price valuations, a colleague was talking about putting its balance sheet on "autopilot", and Bank of England Governor Mark Carney had pirouetted from saying that now was not the time to think about rate hikes to saying they would soon have to be discussed.

Despite the initial knee-jerk moves, markets remained relatively cautious, wary that subdued global inflation and wage growth - which policymakers openly admit they are struggling to understand - will delay their reactions.

A Bank of England rate hike is now 80 percent priced-in by March next year, and Canada is at 70 percent after talk of rate rises there too this week.

But traders are still not banking on another Fed rate rise in the next 12 months, and the ECB is not expected to raise rates in that timeframe either, even if privately some of its hawkish members say it could.

PULLING OUT THE PLUG

Between them, the Fed, the ECB, the BoE and the Bank of Japan have hoovered up almost $15 trillion of bonds over the last eight years, roughly three-quarters of what the U.S. economy is worth.

The current rate of accumulation is still almost $200 billion a month, split almost equally between the ECB and BOJ. Even if $50 billion was lopped off in the next six months or so as the Fed trims its balance sheet, it will all be carefully managed.

Therefore the assumption is that there won't be a meaningful reduction in liquidity for at least a year.

"The sink will be broadly as full as it has been, even with the plug gradually being removed," said Neil Williams, chief economist of UK fund manager Hermes.

The banks will be all too aware that, despite all their cheap money, a decade on from the big credit crash, economies remain highly indebted.

Global debt levels have climbed $500 billion in the past year alone to a record $217 trillion, one of the most authoritative trackers of global capital flows, the Institute of International Finance (IIF), said this week.

It adds up to 327 percent of the world's annual economic output. The IIF warned of "rollover" risks in store, especially in emerging markets, where $1.9 trillion will have matured by the end of 2018.

SEB's Peterson thinks equities will be the place to be as rates rise, but that any sign of corporate borrowing costs starting to rise away from official interest rates should be seen as a warning.

The difference between the 10-year U.S. Treasury yield and the average on Barclays' corporate bond index is currently just 0.3 percentage points - 2.2 compared to 2.5 percent - virtually the lowest in three years.

SEB's Peterson said the end of central bank largesse would be a big change, but that "as long as they do it in a transparent way and with good care for the markets, it is natural".

(Additional reporting by Jamie McGeever and Vikram Subhedar; Editing by Kevin Liffey)