A prevalent notion is that the Fed expanding its balance sheet (QE) equates to a lower dollar. After-all, they purchase assets by “printing” dollars, expanding the dollar’s supply, so it makes sense that the dollar would fall. But, let’s take a closer look at this idea. If you look below, I have a chart of the Fed’s balance sheet alongside the trade weighted dollar index. Since the Fed began expanding their balance sheet in 2008, there is a clear positive relationship with the Fed’s balance sheet and the dollar. When the Fed expands its balance sheet, the dollar goes up and when the Fed’s balance sheet stays flat, the dollar ranges. Over the last several months, the Fed’s balance sheet has expanded, but the dollar has fallen, creating a divergence. If the positive correlation between the two is going to come back together, that means one of two things will happen: the Fed’s balance sheet will contract (not going to happen) or the dollar is going to rise. My money is on the latter of the two. This divergence suggests to me that the dollar is in a corrective phase and it will rejoin the Fed’s balance sheet to the upside, like it has every time since 2008.
Now, if the expansion of the Fed’s balance sheet is increasing the money supply, why would the dollar rise? If the Fed is expanding its balance sheet, that is not a good sign. That means there are liquidity holes in the system that the Fed is trying to plug by “printing” money. There is lack of liquidity because it is being destroyed somewhere in the system. As a side note, when I say destroyed I’m talking about liquidity drying up due to credit defaults, banks tightening lending standards, etc. If you look (below) at the H.8 data (commercial banks assets and liabilities), you will see that credit has contracted about $460 billion since May. Now, the Fed has “printed” a couple trillion, but this data does not take into consideration the dollars that have been destroyed in the eurodollar (not EURUSD) market. If the Fed must continually expand their balance sheet, it means dollars are getting destroyed at a faster rate than the Fed has been able to put them back into the system. The eurodollar market is vastly bigger than the domestic US dollar market. A couple of trillion dollars from the Fed is a relatively small percentage of the eurodollar market. You may be thinking, then why doesn’t the Fed print more? Well, first, they will, but the eurodollar market is neither on the Fed’s radar nor is it a measurable market due to its vastness and elusiveness; therefore, it is not included in the money supply (I spoke more about the eurodollar market and money supply here). So, if the Fed is expanding its balance sheet, it means dollars are being destroyed elsewhere at a faster rate, hence the positive relationship we have seen the last 13 years between the dollar and the Fed’s balance sheet. I expect this trend to continue.
There is substantial risk associated with trading in the financial markets. You are solely responsible for your own financial decisions. Information on Ryan Miller Trading Economics is for educational purposes only. Ryan Miller Trading Economics will not be held responsible for any losses you incur. Ryan Miller Trading Economics does not provide any trading advice and is not a professional investment service. Past performance is not necessarily indicative of future results. There is a substantial risk of loss associated with trading currencies, securities, options, futures, equities and options on futures and currencies. Currencies, Futures, Options, Bonds, Equities and other securities trading all have large potential rewards, but they also have large potential risk and may result in monetary losses. You must be aware of the risks and be willing to accept them in order to invest or trade in these markets. Ryan Miller Trading Economics is neither a solicitation nor an offer to Buy/Sell currencies, futures, options, bonds, or equities. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this website. The past performance of any trading system or methodology is not necessarily indicative of future results.
Recommended Content
Editors’ Picks
EUR/USD drops below 1.0800 after German Retail Sales data
EUR/USD has come under fresh selling pressure and trades below 1.0800 after the data from Germany showed that Retail Sales declined by 1.9% MoM in February. Resurgent US Dollar demand is adding to the downside in the pair. US data are next in focus.
GBP/USD stays weak near 1.2600 amid market caution
GBP/USD remains defensive near 1.2600 in European trading on Thursday. The hawkish tone from Fed Governor Christopher Waller keeps the US Dollar afloat amid a cautious trading environment ahead of key US data releases and the Good Friday trading lull.
Gold price holds strength ahead of US core PCE inflation
Gold price holds onto gains near $2,200 in Thursday’s European session. The precious metal exhibits firm footing ahead of the United States core PCE Price Index data for February, which will be published on Friday.
XRP price falls to $0.60 support as Ripple ruling doesn’t help Coinbase lawsuit against SEC
XRP programmatic sales ruling by Judge Torres was completely rejected by another US Court that ruled in favor of the SEC in a lawsuit against Coinbase.
Portfolio rebalancing and reflation trades emerge into Q2
Yesterday’s price action pointed at a possible end-of-quarter portfolio rebalancing as the session saw the laggards of the quarter like Apple and Tesla gain, and the stars like Microsoft and Nvidia retreat.