Three Central Banks Shrink Balance Sheets Together

The biggest change in the global financial environment in August 2026 was that the balance sheets of all three central banks turned negative month on month. FRB total assets declined 0.11% from the previous month, the first contraction in the available data period (since February 2026); the ECB declined 0.52%, while the BOJ monetary base fell 0.77%. In interest rates, both the US 10-year Treasury yield, at 4.730%, and the euro-area AAA 10-year yield, at 3.279%, rose from the previous month. However, the increase in 2-year yields was larger, narrowing the 10Y-2Y spreads to 0.390% in the US and 0.473% in Europe. Whereas long-end yields rose more sharply in July, the defining feature of August was that the center of the upward move shifted toward the short end of the curve.

1. Interest-Rate Environment in Three Regions: Levels and Direction

Both the US and Europe experienced a “2-year-led rise,” with yields pushed higher from the short end of the curve.

According to data published by FRED, the US 30-year Treasury yield was nearly unchanged at 5.210%→5.220%, with the increase becoming smaller at longer maturities. ECB statistical data likewise show that in the euro area, the increase in the 2-year yield exceeded that of the 10-year yield, indicating a pattern similar to that of the United States.

There is a difference in the amount of information available on the relationship with policy rates across regions. The ECB deposit facility rate was left unchanged after being raised from 2.000% to 2.250% in June, but the deposit rate–2Y gap widened in negative territory from -46bp in July to -56bp in August. By definition, this means that the margin by which the market rate exceeds the policy rate widened. In the United States, the Fed Funds rate has been N/A since February 2026, so the gap for the current month cannot be calculated; the US policy rate level and its trajectory are therefore excluded from the quantitative assessment in this column.

For Japan, August JGB yields are not available. Based on derived values using data published by the Ministry of Finance as of January, the 10Y-2Y spread was 0.996% and the US-Japan 10-year spread was 2.013%, confirming a steeper curve and larger cross-border interest-rate differential than in the US and Europe. Japan’s interest-rate levels as of August are excluded from the analysis, and Japan is evaluated indirectly through the monetary base, M2, and prices.

So What: Short-end yields rose in both the US and Europe, reaching year-to-date increases of +82bp for the US 2-year and +76bp for the European 2-year. Even during a period when no policy-rate change has been confirmed, short-term market funding rates have shifted upward.

2. Comparative Analysis of Yield-Curve Shapes

From a Nelson-Siegel perspective, August saw a simultaneous rise in Level and narrowing of Slope in the US and Europe—in other words, concurrent bear-flattening.

The Level (10Y yield) stood at 4.730% in the US and 3.279% in Europe, both the highest levels in the available data since January 2026. Meanwhile, the Slope narrowed in both regions from July. Because currency and inflation environments differ, no judgment is made about the relative levels; however, the direction of change and curve shape were broadly synchronized.

The distribution of yield increases by maturity differs from month to month. In July, the US 30-year yield rose from 4.860% to 5.210%, an increase of +35bp, while both the 10Y-2Y and 30Y-10Y spreads widened. In August, the 30-year yield rose only +1bp, while the 2-year yield rose +11bp, narrowing both spreads. The center of the upward yield move shifted from the long end to the short end. The available data do not include indicators that separate the expected path of short-term rates from the term premium, so it is not possible to identify which was the primary driver of the change.

The range of possible interpretations also requires attention. August’s flattening could be interpreted as long-term yields being restrained by expectations of an economic slowdown, but neither the 10-year nor the 30-year yield declined; both remained near the highs of the available period. The data provide no evidence of a decline in long-end yields. At least one point is clear: this was not flattening accompanied by lower long-term yields.

So What: The curve change in August occurred as the short end caught up while long-term bond yields held their levels. The US 10Y-2Y spread was 0.390%, leaving less than 40bp of room before a yield curve inversion.

3. Excess Liquidity and the Balance Sheets of the Three Central Banks

The simultaneous contraction of the balance sheets of all three central banks was the key liquidity development in August.

FRB total assets had continued to expand on a year-to-date basis, rising from $6,587,568 million in January to$6,730,912 million in August, an increase of +2.18%; however, August marked the first month-on-month decline. Over the same period, ECB total assets fell from €6,289,997 million to €5,913,041 million, a decline of -5.99%, indicating an ongoing phase of asset reduction. The August contraction slowed from -2.83% in July, but the direction did not change. The BOJ monetary base declined from ¥559,203.9 billion to ¥554,925.9 billion, or -0.77%, and was on a contractionary path in both of the two available months.

The combined total of the three central banks, estimated in US dollars, fell from $16.9 trillion in July to$16.83 trillion in August, a decline of -0.4%. The total in the $13 trillion range before June excluded the BOJ; therefore, the sharp increase from June to July reflected a change in the aggregation scope, not an expansion of liquidity. Month-on-month comparisons should be made from July onward, when the BOJ is included.

Money supply does not necessarily move in the same direction as central-bank balance sheets.

• US M2 was $23,208 billion in August, down 0.4% month on month and up 5.62% year on year (slowing from +6.43% in July)
• Japan’s M2 was ¥1,297,007.4 billion, a marginal month-on-month increase of +0.04%, moving in the opposite direction from the contraction in the monetary base
• Euro-area M3 was last reported at a year-on-year increase of +3.44% in January

So What: While central-bank quantitative contraction is progressing, US M2 remains in the 5% year-on-year growth range, and Japan’s M2 has not begun to decline. The contraction of central-bank balance sheets and broad money are not moving in the same direction. The factors generating this divergence—such as changes in asset holders and fiscal or credit demand dynamics—cannot be identified from the available data and must be assessed through the direction of the M2 series in subsequent months.

4. Cross-Regional Spreads and Divergence

The US-Europe 10-year spread narrowed slightly from 1.479% in July to 1.451% in August. Year to date, it narrowed from 1.357% in January to 1.256% in March before remaining in the 1.4% range from May onward. The August narrowing resulted from the euro-area 10-year yield rising more (+8bp) than the US yield (+5bp). In the euro area, the deposit rate–2Y gap widened to -56bp, moving in the same direction as the short-term market rate’s upward divergence from the policy rate.

The US-Japan and Japan-Europe 10-year spreads have been N/A since February, so August cross-border interest-rate differentials cannot be evaluated quantitatively. As of January, derived values showed a US-Japan 10-year spread of 2.013% and a Japan-Europe 10-year spread of -0.656%. Since then, the US 10-year yield has risen +47bp and the European 10-year yield +38bp; if Japanese yields have not risen by a similar amount, the interest-rate differentials would have widened. However, because August data for Japan are missing, no conclusion can be drawn about the nominal interest-rate differential environment for the yen carry trade.

So What: The US 2-year yield has risen +82bp year to date, and the benchmark rate for short-term dollar funding has clearly shifted upward. However, the available data do not include information on international capital flows or funding costs by type of borrower, so the transmission effects are not assessed. The fact that the US-Europe 10-year spread has remained in the 1.4% range for three months indicates, at least, that the transatlantic interest-rate differential has not shifted to a new range.

5. Relationship with the Inflation Environment

Japan’s CPI has reaccelerated from its April trough, moving in the same direction as rising US and European yields. According to data from the Statistics Bureau of Japan, July 2026 headline CPI rose +1.9% year on year, core CPI +1.8%, and core-core CPI +1.9%; all three indicators increased from June (+1.6%/+1.6%/+1.7%).

The phase, however, has two distinct stages. Headline inflation slowed from around +3.0% in October–November 2025 to +1.4% in April 2026, then reaccelerated through July. Core-core inflation declined from +2.4% in March to +1.8% in May before returning to +1.9% in July. Underlying inflation appears to have bottomed out in the upper 1% range.

This reacceleration in prices coincided temporally with the contraction in the BOJ monetary base (-0.77% in August). However, the available data contain no information indicating the basis for policy decisions, so the causal relationship between the two cannot be identified. What can be confirmed is their simultaneity: the monetary base was negative month on month as prices returned to the upper 1% range. Together with the 2-year-led rise in US and European yields, this indicates that financial conditions in all three regions have not shifted toward easing.

So What: With Japan’s core CPI returning to +1.8%, the pressure to reverse quantitative normalization from the inflation side remains weak. Whether core CPI holds at 1.8% next month will provide the starting point for assessing Japan’s financial conditions.

6. Consistency with the Real Economy

The coincident index improved while the leading index remained flat. According to Cabinet Office data, the June 2026 coincident index was 118.5 (117.9 in May), the leading index was 116.5 (unchanged from May), and the lagging index was 111.8. The leading index remained at 116.5 in both May and June, indicating that the rise from 112.5 in January had paused.

The following relationships with interest rates can be identified.

• The improvement in the coincident index indicates that current business conditions have not deteriorated
• The flat leading index indicates a pause in the improvement momentum that had continued from January
• The lagging index edged down from 112.1 in January to 111.8 in June, showing no signs of overheating

So What: Real-economy indicators do not show a sharp deterioration, but the plateau in the leading index indicates a slowdown in the pace of economic improvement. Whether the leading index falls below 116.5 in the coming months will be a key dividing point in assessing Japan’s economic phase.

7. Corporate Sentiment

The BOJ Tankan for Q2 2026 shows a clear contrast between current improvement and cautious forward-looking views. The business conditions DI for large manufacturers improved by +5 from 17 in Q1 to 22, but these firms expect the index to deteriorate by 8 points to 14 in the outlook. The DI for large nonmanufacturers was 37 (36 in Q1), with an outlook of 29, while the DI for small and medium-sized manufacturers improved to 9 (7 in Q1).

The asymmetry is notable: the current-conditions DI has improved for four consecutive quarters, while the outlook DI alone remains at a low level. During the same period, global interest-rate conditions saw the US 10-year yield rise +47bp year to date and the European 10-year yield rise +38bp. The two developments coexisted temporally, but the available data do not indicate the factors behind the Tankan outlook and therefore cannot establish a causal relationship.

So What: The current-conditions DI for large manufacturers, at 22, is the highest in the available period, with no sign of contraction in corporate activity. The next survey will show where the Q2 outlook of 14 ultimately lands in actual results and will provide evidence of whether sentiment has turned.

8. Japan’s External Position

The available range of Ministry of Finance trade statistics extends only through December 2025, so the latest conditions cannot be assessed. In December, exports were ¥10,407.7 billion and imports ¥10,312.9 billion, producing a trade surplus of ¥94.8 billion; November recorded a surplus of ¥306.0 billion. The balance shifted from deficits of ¥277.7 billion in September and ¥242.9 billion in October to surpluses.

The monthly surplus remains small, below ¥1 trillion. The impact of real-economy yen supply and demand is therefore limited. Because there is a data gap of more than three months, developments in Japan’s trade balance in 2026 will need to be checked in the next update.

9. Outlook and Risk Scenarios

Base case: US and European interest rates continue rising, led by the 2-year sector, while the 10Y-2Y spreads remain in a zone of gradual flattening around 0.4% in the US and 0.5% in Europe. The balance sheets of the three central banks continue to contract gradually in aggregate, but broad money has not declined, as indicated by US M2 growth in the 5% year-on-year range; the data show no sign of an abrupt change in liquidity indicators.

Risk scenarios:

• Renewed rise in long-term US yields: If the +35bp surge in the 30-year Treasury yield seen in July recurs, the US 10-year yield could move higher and the US-Europe spread could widen from 1.451% to above 1.5%
• Further rise in euro-area short-term rates: If the deposit rate–2Y gap widens further in negative territory from -56bp, a rise in the European 2-year yield would drive another phase of flattening in the euro-area curve
• Continuation of FRB balance-sheet contraction: If the -0.11% contraction in August continues for several months rather than proving temporary, FRB total assets would shift from a year-to-date expansion trend to a clear decline
• Renewed acceleration in Japanese inflation: If core CPI rises further from +1.8%, the framework for assessing Japan’s financial conditions would change, requiring a reassessment of the assumptions underlying cross-border interest-rate differentials

Watchpoints:

1. Whether FRB total assets decline for two consecutive months, confirming a shift toward balance-sheet contraction
2. Whether the US 10Y-2Y spread narrows further from 0.390% and approaches yield curve inversion
3. The direction of the ECB deposit rate–2Y gap from -56bp
4. Whether Japan’s leading economic index can remain at 116.5
5. Whether year-on-year US M2 growth slows from +5.62% into the 4% range

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Data Sources

• Source: Federal Reserve Bank of St. Louis (FRED), https://fred.stlouisfed.org/
• Source: European Central Bank, Statistical Data Warehouse
• Source: Ministry of Finance, Japan, Japanese Government Bond Interest Rate Information
• Source: Bank of Japan, Time-Series Data
• Source: Statistics Bureau of Japan, Consumer Price Index; Cabinet Office, Indexes of Business Conditions; Ministry of Finance, Trade Statistics; Bank of Japan, Tankan—Short-Term Economic Survey of Enterprises

Glossary

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This column was automatically generated by AI integrating data from the Federal Reserve Bank of St. Louis (FRED), the European Central Bank (ECB) Statistical Data Warehouse, Japan Ministry of Finance, and Bank of Japan statistics as a global fiscal and liquidity analysis resource. This is not a recommendation to buy or sell any financial instruments. Please make investment decisions at your own responsibility and consult professionals as needed.