1,000 Pips in 90 Days? The Last Time Central Banks Did This, Markets Went Wild

Understanding Central Bank Balance Sheets

I remember the first time I realized how powerful central bank decisions could be. It was like watching two close friends, the Federal Reserve (Fed) and the European Central Bank (ECB), juggling enormous amounts of money and bonds. Each one has a balance sheet that shows how many assets they hold in return for the currency they release into the market. When a balance sheet grows, it generally means the central bank is buying government bonds and other assets to pump more liquidity into the financial system. This strategy is often called Quantitative Easing, or QE, and it can boost stock markets because investors sense that money is flowing more freely.

Identifying the Patterns in EURUSD

If you place the Fed and ECB balance sheets side by side, you start to see patterns that can offer a significant advantage for predicting movements in EURUSD. When you catch these patterns early, the returns can be tremendous.

Four Key Scenarios

First scenario: The Fed expands its balance sheet while the ECB reduces its own. This means the Fed is effectively flooding the market with dollars while the ECB makes euros relatively scarce. That typically sends EURUSD higher because the euro becomes more valuable compared to a more abundant dollar.

Second scenario: Both the Fed and ECB expand their balance sheets, but the Fed does so more aggressively. The effect can still favor the euro because the dollar flood tends to be stronger, but overall liquidity is up for both currencies. EURUSD can still rise in this environment, though not as dramatically as the first scenario.

Third scenario: The Fed pulls back on liquidity (contracts its balance sheet) while the ECB expands. With fewer dollars in circulation and more euros available, EURUSD tends to move down quickly. One historical example is the sharp drop in EURUSD during the third quarter of 2014.

Fourth scenario: Both central banks contract, but the Fed does so faster than the ECB. This environment usually sends EURUSD lower because the dollar becomes relatively scarcer.

Recent Observations in Late 2024

In the weeks starting September 30, 2024, and December 23, 2024, the ECB slightly expanded its balance sheet while the Fed contracted. As a result, EURUSD still declined by 800 pips in the first instance and 300 pips in the second. That might seem counterintuitive at first, but these moves highlight how sensitive currency markets can be to who is adding liquidity and who is taking it away.

Looking Ahead to Q1 2025

Forecasts now suggest that by the end of the first quarter of 2025, the ECB may contract relative to the Fed (see here). If that shift does occur, EURUSD could see significant upward momentum, and any asset correlated to the US dollar could also experience substantial moves.

Conclusion: Trading the Mega Trend

Central bank balance sheets are a window into the forces that drive global finance. Keeping track of which bank is injecting money and which one is pulling back can provide a guiding light for spotting the next major trend in EURUSD and other dollar-related markets. When one side changes its approach, the entire market feels the impact. If you monitor these shifts closely, you might spot the next opportunity before everyone else does.

As always I will post my findings and keep you in the loop when this happens, possibly as soon as March 2025.

Until next time,
Your Partner in Profitable Trading