Latest Euro Spike amp Flow vs Stock Analysis

The latest euro spike emerging from two factors:

  1.    Market News International quoting Eurozone sources that euro reflects renewed confidence in Eurozone and No exit soon from ECB’s non-standard measures.
  2.    Fitch announced Greece has hit its fiscal target for 2012.

Today’s news showing the ECB balance sheet to have shrank to an 11-month low of €2.77 trillion ($US 3.7 trillion, means the balance sheet has declined 8.0% so far this year, which underlines the implicit tightening of the central bank and explains the euro’s out-performance relative to other currencies.

The ECB balance sheet has fallen 3.5% YTD to $3.7 trillion
The Fed balance sheet has risen 3.5% YTD to $3 trillion
The BoE balance sheet has fallen 1.0% YTD to $ 634 billion
The BoJ balance sheet has risen 7.3% YTD to $1.7 trillion.

Although the ECB’s balance sheet is of greater size than that of the Fed, flows matter more than stock in currency markets when comparing central bank balance sheets, thereby highlighting the euro’s out-performance over the last few months. Currencies are best evaluated against a common denominator such as gold, which reflects the euro’s out-performance against the metal relative to other majors (see chart). This shows the euro’s 2.8% increase against the metal year-to-date, in contrast to the yen’s 7.3% decline over the same period. The most important point to watch in Thursday’s ECB decision is Mario Draghi’s handling of the inevitable question about the euro’s appreciation metal year-to-date, in contrast to the yen’s 7.3% decline over the same period.

This is not 2005

As pundits begin speculating about European officials’ talking down of the euro, it is important to remember that this is not January 2005 when Trichet’s warning of “violent moves” in FX dragged down euro at the time. In 2005, there were two other reasons for the ensuing euro decline that year:
1) Fed began tightening in 2004 and ECB didn’t begin to tighten until Dec 2005;
2) US Homeland Investment Act drove US companies to repatriate funds to take advantage of the Act’s temporary tax cut aimed at drawing capital to the US. Over $270 bn was repatriated by US companies in 2005. When the ECB began tightening in Dec 2005 and the Fed paused in June 2006, the US dollar’s damage ensued.