The balance sheets of the Federal Reserve and ECB have been diverging for a couple of years. The Great Graphic from Pictet shows the evolution of the two balance sheets since the onset of the Great Financial Crisis.
The Fed's balance sheet has not peaked. Tapering of its purchases will continue in the coming months. Even when it is finished with QE3+, the balance sheet may still grow as coupon payments are recycled. As the tapering winds down, there will be greater discussion of the next sequence of events. Should a rate hike proceed the end of the coupon recycling?
The ECB's balance sheet has been contracting as banks repay the LTROs. The ECB's balance sheet may expand or contract at a slower rate starting in September, when the new targeted LTROS (TLTROs) will be available. There is still a great deal of debate over how much the TLTROs facility will be used. There may be fear of a stigma, especially ahead of the Asset Quality Review and the stress tests.
Nevertheless, the takeaway is that the divergence between the Federal Reserve and ECB balance sheets may be a few months away from peaking. While the euro has trended higher since July 2012, it is not obvious that it was driven by the divergent balance sheets. Draghi's dedication to the eurozone project was a critical turning point for the euro. Moreover, there are many cross currents in the foreign exchange market and an exclusive focus on the balance sheets would not have prepared one for the more than 7% euro sell-off in February-April 2013 or the nearly 5% retreat in the middle of last year.
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