Fearful investors look to a world after QE This week in Texas, Dallas Federal Reserve President Richard Fisher voiced perplexity at the market's obsession with "so-called QE3." Mr Fisher is in the hawkish camp that believes no further monetary easing is necessary. His remarks came three weeks after the Bank of Japan announced it had adopted a 1 per cent inflation "goal" and an expanded asset purchase programme. This was just days after the European Central Bank distributed almost €530bn to European banks, bringing its balance sheet to more than €3,000bn. His remarks also come at a time when markets are beginning to anticipate the possibility that the most aggressive easing is coming to an end, even while central banks maintain their promise to keep rates on hold (accounting for a huge part of demand for securities and keeping asset prices artificially high in the process). These cross currents account for a big part of the volatility in the markets today. The explosion of the ECB balance sheet is right up there with that of the Federal Reserve, which has more than tripled its balance sheet since January 2009 to more than $2,500bn. It now owns $1.6tn of treasury debt and more than $800bn of mortgage-backed securities (although it hasn't actually bought any securities in over nine months), according to data from Wells Fargo. Meanwhile, since the global financial crisis, despite its rhetoric, the Bank of Japan has barely expanded its balance sheet - it is in fact lower today as a percentage of gross domestic product than it was in 2005, according to CLSA. Yet this past week, the dollar/yen rate barely moved while the dollar actually weakened against the euro. It isn't clear what is driving currencies these days. Economic fundamentals certainly don't explain relative values and neither does monetary policy. Six months ago, most hedge funds were betting that the euro would soon slide to parity with the dollar. Yet the euro remains puzzlingly strong despite what the ECB is doing. Some say that currency strength reflects the fact that European banks have been selling US assets, converting the dollar proceeds into euros and bringing them home. Others speculate that China has been propping up the euro to help make its own currency more competitive and make its exports more attractive. The Chinese have gradually reduced their holdings of dollar-denominated assets, particularly Treasuries. European debt (particularly German debt) has been the main beneficiary, says Stephen Green, a Hong Kong-based economist with Standard Chartered Bank. Mr Green estimates that China will accumulate $300bn in reserves this year and only half of that will go into US dollar assets. Weak economic conditions alternating with fears of inflation explain central bank thinking. But, as time passes, there will be other factors that may well influence them, especially the fear of losses on their holdings. Now, governments are propping up securities but what happens when you take away that prop? Today, with the Fed sitting on trillions of dollars of both Treasury and mortgage securities, fear of potential losses when QE is finally unwound is becoming more of an issue. For example, both Fed and former Treasury officials say that the US government's exposure to lenders Fannie Mae and Freddie Mac is a big reason for the lack of action in dealing with them. One of the reasons regulators were concerned about Countrywide's fate before Bank of America bought the ailing mortgage lender was because the Federal Home Loan Bank of Atlanta had lent Countrywide a huge amount of money, vastly exceeding credit to any other borrower and held Countrywide collateral in return. If Countrywide went under, that collateral would lose much of its value, according to people familiar with the matter. Fear of losses aren't just confined to Frankfurt, Tokyo and Washington. It prevails to an even greater extent among non-dollar investors in Asia, where currencies are generally on an upwards trajectory. If Beijing were to let its currency appreciate to the extent the west wishes, the value of its foreign currency holdings would drop substantially. The BoJ, ECB and the Fed may not yet be thinking of what happens after they change course, but other central banks surely are.