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The Massive Rise In The Fed's Balance Sheet Will Not Be Enough To Kill The U.S. Dollar

May 07, 2020 4:20 AM ETUUP, FXE, FXY, UDN, USDU2 Comments
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Rothko Research


  • The Fed's balance sheet could reach $12 trillion by the end of 2021, more than 50 percent of the country's GDP.
  • On the other hand, it seems that the ECB has reached its political limits concerning QE.
  • We do not think that the central bank balance sheet differential will matter in the near to medium term.
  • The underperformance of most economies relative to the US will drive the USD higher.

In the past few weeks, some investors have been sharing a few popular charts on the FX markets that overlay the main exchange rates with the yearly change in the central banks’ balance sheets differentials. Historically, we saw in our previous FX articles that two of the most important drivers in the FX market are the real GDP growth differential and the real interest rate differential. However, the titanic liquidity injections from the Fed since the start of the COVID-19 crisis has convinced some participants that the weakening USD scenario is about to materialize in the near to medium term. Figure 1 shows that the Fed’s balance sheet has grown considerably in the past two months, up nearly $3 trillion to a historical high of $6.7 trillion, and is expected to reach $8-9 trillion by the end of the year (40-45 percent of the US GDP). Figure 1 shows the general projections from consensus; the Fed balance sheet could increase up to $12 trillion by the end of 2021. Will it be enough to weaken the US dollar?

Figure 1

Source: Eikon Reuters

The persistent strength of the US dollar in the past 30 months has surprised many investors who have been speculating on a weaker currency on the back of a sharp rise in twin deficits. USD trends have historically lasted for a period of 8 years, and the current rally officially started somewhere in 2012 (depending on the measure of the USD index we use, broad or narrow index), implying that a mean reversion is about to occur.

Figure 2 shows two powerful charts of the EURUSD and USDJPY exchange rates overlaid with the central banks’ (CBs) balance sheet differentials. It is very tempting to conclude that the two main currencies - euro and Japanese yen - are about to experience a tremendous period of

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Rothko Research profile picture
Rothko Research provides frequent analysis and updates on the current global macro themes. Looking at the financial markets from different perspectives, using either economic, political or financial factors, we are not afraid to go against the general consensus and challenge the conventional wisdom.//twitter: @RothkoResearchWebsite: https://rothkoresearch.com/

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in EURUSD over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Comments (2)

netbluesky profile picture
Yup !
Brief and high signal to noise. Great piece thanks.

Although I generally agree with the outlook I think bearish momentum in EURGLD will be even stronger than EURUSD.
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