Last week we discussed [6] what the expectations were for Draghi's OMT - approximately EUR250bn - which coincidentally provided cover for the rest of the year (conditionally) for the entire new issuance of the European Union. Based on EURUSD's recent exuberance - something we saw ahead of QE1 and QE2 - the market is now more than primed for some serious USD debasement. The current EURUSD of 1.2850 implies a Fed-to-ECB balance sheet ratio around 1.11x. If we assume the ECB wil not have to fire its conditional bazooka (of which is priced in 100% likelihood of EUR250bn), then the Fed is expected to conjure a monetization scheme of around USD580bn - anything less would be a disappointment to the market. However, if we assume the ECB will be doing it's bond-buying monetization thing - as per the equity market's expectations - then the Fed will need to come to the table with a bag of swag around USD850bn in order to debase the USD just enough to regain some hope. It seems like the market has priced in a great deal of monetary policy exuberance - especially considering how 'confident' consumers appear to be [7].
EURUSD vs Fed/ECB balance sheet 'expectations'
[8]
and via Citi - the action of EURUSD leading up to QE1 and QE2 was positive only to be followed by the more significant sell-off...
[9]
[chart shows EURUSD performance rebased to 100 at T-40days]
Given the market's very tightly related correlations, a 3-5% drop in EURUSD could damage US equities quite severely if the USD debasement does not arrive. A shift to 1.20 (which is where Fed/ECB balance sheets are currently positioned) would imply a drop to 1340ish for the S&P 500...
[10]
Chart: Bloomberg