Tag Archives: balance sheet ratio

Do you believe EUR/USD is driven the by FED/ECB balance sheet ratio?

Do you believe EUR/USD is driven the by FED/ECB balance sheet ratio?

A popular theory is that an approximate proxy for money printing is the absolute size of the central bank in question. This is a simplification since monetery operations can be and are collaterilized (such as ECB’s LTRO and LTRO2) or direct (such as QEs). However, the weakness of Euro really only started after ECB started expanding its balance sheet over the last half a year or so (the b/s expansion started even before LTRO1 in December 2011).

What do you think? Is this a reliable trend indicator (currently pointing to further Euro weakening as ECB’s balance sheet tops that of FED’s by some margin)?

Here is one take on this theory from ZeroHedge, predicting either Euro drop or FED QE3:

With $700 billion in QE3 already priced in, who will blink first?

zerohedge.com

Something interesting happened when the ECB announced last week that its balance sheet was about to rise by €1 trillion gross, and hit a record €3 trillion net earlier today: the EURUSD barely budged. Why? Because as a reminder, the

 

 

that’s a tough one. I think there are several factors at play here, and they’re all conflicting.

1. I believe that it is both Fed and Bank of China policy to systematically devalue their currencies in order to gain an export advantage. In the case of the Fed, an added incentive is that a devalued currency makes it easier to pay off massive debts. In both regards, I agree with Jim Rickards, the author of Currency Wars.

The U.S. government has essentially been shorting its own currency by lending dollars to the IMF so it can, in turn, issue SDR’s. I certainly think it’s possible that the Fed has also sold EUR for USD in order to put a floor in the Euro. This may or may not take the form of direct intervention. As you know, the Fed can simply open swap lines and, in doing so, buy Euros, thus pushing the price up.

1. At the same time, with the ECB massively expanding its balance sheet, I don’t think there’s any question that this is having an impact on the value of the EURUSD pair.

1. Although the world’s central banks possess considerable power, in the end, they’re not more powerful than the market. Traders will simply pounce on weakness, and by weakness, I don’t necessarily mean the weakness of a currency. I’m referring to the weakness of other traders’ positions. Once traders smell that someone’s in trouble, they’ll execute into the market in order to get them to liquidate their trades, thus creating order flow from which they can profit.

This is why you’ll often see markets reverse after central banks intervene. It happened last October after the Swiss National Bank effectively pegged the CHF to the EUR. And it happened in April 2010 after the BoJ intervened in the Yen market.

There are so many ways to interpret what’s going on. On one hand, as Zero Hedge points out, everyone’s expecting QE3 in some form (indeed, I think the Fed just announced some sort of bond swap program today – refer to the CNBC Jim Grant interview (http://bit.ly/wsTMJi). On the other hand, the ECB’s balance sheet may be expanding faster than the Fed’s.

To address your last point, I think the best indicator of any market’s trend is to keep it as simple as possible. Personally, I use a proprietary system, which does an excellent job. I’d be happy to share it with you if you want to message me directly, as I don’t want to use this board to promote anyone’s services.

This is a great topic for discussion, so by all means, let me know what you think of my rant.

 

 

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