A
major reason for support for the Euro in recent weeks has been a lack
of new easing measures from the European Central Bank. Although a
FLS-like LTRO may be in the works, many have correctly pointed to the
dramatic contraction in the ECB’s balance sheet over the past year as a
reason for the Euro’s elevated exchange rate. The ECB’s balance sheet
has declined by -24.6% in the 52-weeks ending December 6, 2013; to
contrast, the Federal Reserve’s balance sheet has grown by +36.8% over
this same period; and the Bank of Japan’s has growth by +40.7%.
Taking
these data a step further, we see that the ratio of the Fed’s balance
sheet to the ECB’s balance sheet – which stood at 0.96 this time in
December 2012 – is now at 1.72. On a relative basis, the Fed’s balance
sheet has grown +79.2% relative to the ECB’s over the past year. We
believe this has been the prime reason for a generally improving EURUSD
in 2013. As such, any data or event that could alter the dynamic behind
the Fed’s and the ECB’s balance sheets is paramount.
Accordingly, our
focus this week for the Euro is not solely on domestic developments but
rather from those abroad (this will be a major theme across FX, not
just the Euro). The Fed’s policy meeting on Wednesday should prove to be
rather disruptive to markets, irrespective of what else might be
happening fundamentally or technically, as it did in on June 19
(beginning of taper speculation) and September 18 (surprise non-taper
decision).
The Euro’s role in the Fed’s taper production is
complicated. In June, the Fed meeting marked a two month top in the
EURUSD as the pair slid from above 1.3400 at the time to under 1.2800
over the next four weeks. Yet with the USDJPY rallying, the EURJPY,
after seeing several multi-hundred point swings in the days after the
June FOMC, eventually settled higher. The EURAUD took a straight line
up. In the “taper on” environment, the Euro suffered against the US
Dollar, was at first neutral against the low yielding safe havens, and
appreciated sharply against the commodity currencies.
We highlight
these outcomes as it is possible the market isn’t positioned for a QE3
taper in the slighted. True, US yields have risen over the past several
days; but consensus estimates for the composition of QE3 show that
$85B/month in asset purchases is still expected going into 2014. A
non-taper outcome, like in September, could produce a swiftly weaker US
Dollar, and strength developing in the higher yielding and emerging
market currencies (at the Euro’s expense). But if the Fed does taper,
market participants, by and large, will be caught off guard. Indeed, the
disruptive nature of the FOMC decision this week could unhinge FX
markets from recent trends,tempering any impact seen from any Euro-borne
developments over the coming days. –CV
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