Impact of Monetary and Fiscal Policy on FX Markets, Key Central Bank Rate Decisions From ECB, BoC and Fed, US Dollar, Euro, Canadian Dollar Analysis – TALKING POINTS
- How do monetary and fiscal policy measures impact currency markets?
- What is the Mundell-Fleming model and why does it matter for FX traders?
- How has policy from the Fed, ECB and BOC impacted USD[1], EUR[2] and CAD[3]?
MARKETS HAVE PASSED THE POLITICAL EVENT HORIZON
For foreign exchange (“forex” or “FX”) traders, the constant background noise that politics represents is an inescapable blackhole. Traditional media drowns in punditry, while social media drowns in puns. It doesn’t matter what asset class you’re trading either.In recent years, even a single tweet from a politician has had the capacity to move not only currencies but also bonds,commodities, and equities.
In an increasingly fractious landscape, traders need a framework by which to interpret information and understand political developments as they happen. After all, politics can become policy after enough time and effort. To this end, FX traders need a way to interpret information and political developments in the context of how fiscal policy could change and how that might impact their portfolios.
Market participants need to pay attention to more than just fiscal policy, however. With central bank activity having gained considerable traction during the Great Recession and thereafter, monetary policylooks to be a powerful lasting influence on markets. Therefore, FX traders need a viable framework to analyze both fiscal and monetary policy in tandem.
ECONOMISTS HAVE A SOLUTION BEYOND THE IS-LM MODEL
Fortunately, one such framework exists: IS-LM-BP model, or what’s known colloquially as the Mundell-Fleming model. Through this framework, FX traders can analyze how directional changes in fiscal policy (e.g. changes in taxes or government spending)
