QE and QT: How Central-Bank Balance Sheets Move Currencies

Does QE weaken a currency? As a general rule, yes — quantitative easing expands the money supply, depresses yields, and signals lower rates for longer, reducing the currency's appeal to global capital. But the full answer is more nuanced, because exchange rates are always relative: what matters for currency pairs is not whether a central bank is running QE, but whether it is running more QE than its counterpart. That relative dimension is where the real FX moves are born.

What Is QE?

Quantitative easing is a monetary policy tool central banks use when conventional rate cuts are exhausted or insufficient. Instead of simply setting an overnight rate, the central bank creates new money and uses it to buy assets — typically government bonds and, in some programmes, mortgage-backed securities or corporate debt. This injects reserves into the banking system and pushes down yields across the curve.

The Federal Reserve pioneered modern QE in the 2008 financial crisis and deployed it again in 2020 in response to the pandemic. The Fed's announcement on March 15, 2020 authorised approximately $700 billion in new asset purchases. By the time QE4 ended in spring 2022, the Fed's balance sheet had grown from roughly $4.2 trillion to $8.8 trillion — more than doubling in about two years, as reported by the Federal Reserve's balance-sheet data.

How QE Transmits to the Exchange Rate

Two main channels connect balance-sheet expansion to currency weakness.

The portfolio-balance channel: When the central bank buys up domestic government bonds, it drives their yields lower. Investors holding those bonds are paid off in cash and need to find return elsewhere. Some shift into domestic equities; others look abroad — buying foreign bonds or assets that offer better yields. That outflow requires selling domestic currency to buy foreign currency, weakening the exchange rate.

The signalling channel: QE is also a forward commitment. By announcing large-scale purchases, a central bank signals that policy rates will stay low for an extended period. Lower expected future rates reduce the interest-rate differential that normally attracts foreign capital, and the currency depreciates to reflect that reduced yield advantage. A CEPR VoxEU analysis of multiple QE programmes confirms this signalling effect is a primary FX transmission mechanism.

The ECB's experience in 2015 illustrates both channels cleanly. When the ECB announced its Public Sector Purchase Programme on January 22, 2015 — €60 billion per month of bond purchases — the euro immediately depreciated, losing roughly 10% in effective terms in the months that followed.

What Is QT?

Quantitative tightening is the reverse operation. The central bank stops reinvesting the proceeds of maturing bonds (passive runoff) or actively sells assets from its portfolio. This drains reserves from the banking system, puts upward pressure on yields, and signals tighter monetary conditions ahead.

The Fed launched QT in June 2022, allowing up to a capped amount of Treasuries and mortgage-backed securities to mature each month without reinvestment. By late 2025, the Fed's balance sheet had shrunk by roughly $2.4 trillion from its peak, falling to around $6.6 trillion, according to Cleveland Fed research. The combination of aggressive rate hikes and QT in 2022 drove the DXY dollar index to a twenty-year high, touching 114 in September 2022.

For the full story of that dollar surge, see our post on the strong dollar of 2022 and how bond yields drive currencies.

Relative QE Is What Drives Currency Pairs

The key insight for forex traders is that exchange rates are always a relative comparison. If the Fed is running QE at $120 billion per month and the ECB is running €80 billion per month, neither currency is particularly weak relative to the other in a vacuum. What matters is the divergence: who is expanding faster, who is pivoting to tightening first, and who still has QE running when others have stopped.

The 2022 USD surge is the cleanest recent example of relative QE at work. The Fed was the first major central bank to pivot to QT and the most aggressive on rate hikes. The ECB was late to the tightening cycle. The BoJ maintained QE and yield-curve control throughout. The divergence produced a historically strong dollar against virtually every major currency simultaneously.

The Bank of Japan: The World's Largest QE Experiment

No central bank has run a balance-sheet expansion as prolonged or as extreme, relative to its economy, as the Bank of Japan. Japan first introduced QE in 2001, the first major central bank to do so. Under Governor Haruhiko Kuroda, the BoJ launched Quantitative and Qualitative Easing (QQE) in April 2013 — doubling the monetary base within two years.

The yen responded as theory predicts. In 2013 alone, USD/JPY moved from around 87 to above 105 — a depreciation of roughly 20% — as the BoJ signalled an unlimited commitment to money creation while the Fed was tapering its own QE. The BoJ later introduced Yield Curve Control (YCC) in 2016, pinning the 10-year Japanese Government Bond yield near zero and the short-term rate at −0.1%, which kept the yen structurally weak even as other central banks began normalising.

The extreme of this divergence came in 2022–2023: as the Fed aggressively hiked rates and ran QT, the BoJ maintained its ultra-easy policy. USD/JPY surged from roughly 115 in early 2022 to above 150 by late 2022 — a level not seen since 1990. Follow the Japanese yen currency page on the meter for the current macro score.

Real Yields: The Deeper Driver

As with all monetary-policy tools, the real (inflation-adjusted) yield differential is ultimately what drives capital allocation between currencies, not the nominal rate or the pace of balance-sheet change in isolation. When the Fed ran QT in 2022, it was simultaneously hiking nominal rates above the prevailing inflation rate, turning real yields positive for the first time in years. That combination — balance-sheet shrinkage plus positive real rates — was doubly bullish for the dollar.

Conversely, in 2020 the Fed's massive QE pushed nominal yields to all-time lows while inflation was rising, keeping real yields deeply negative. The dollar softened because there was little incentive for global capital to hold dollar assets paying negative real returns. See our post on real yields and currencies and how central banks move currencies for the framework in full.

Practical Takeaways for Watching QE and QT

1. Compare balance-sheet trajectories Is one central bank expanding while another contracts? That divergence is the FX signal. Absolute size matters less than direction and pace relative to peers.
2. Watch the announcement, not just the deed QE and QT work partly through expectations. A credible signal of future balance-sheet changes moves currencies before the first purchase or sale happens.
3. Check real yields Balance-sheet policy matters most when it shifts real rates. If QT is running but inflation is still outpacing nominal yields, the tightening effect on the currency is muted.
4. Look for sequencing risk Markets pay attention to which central bank pivots first. Being the first to tighten while peers are still easing is the most powerful bullish catalyst for a currency.

The Pip Theory macro strength meter tracks the interest-rate and real-yield pillars across all eight majors, which directly reflect the changing cost of holding each currency as QE and QT cycles evolve.

Educational macro context only — not investment advice.