So, what happened between then and now? More specifically, why are market players paying more attention to the EU referendum, Trump’s policy decisions, the upcoming elections in the euro region, and other political headlines than the latest central bank decisions?
Let’s explore four possible reasons why politics is making monetary policy boring again:
1. Central banks have already pushed the pedal to the metal
Major central banks have done their best to stimulate economic activity since the global financial crisis erupted. This includes cutting interest rates left and right, purchasing highly-rated assets, and structuring programs to encourage banks to lend to businesses and consumers.
But that was almost a decade ago and, despite their overly stretched balance sheets, central bankers are no closer to achieving their already toned down growth and inflation expectations. So, with central banks already pushing the pedal to the metal, average Joes and Janes are now looking to the government for additional stimulus.
Remember that monetary and fiscal policies need to go hand in hand to achieve a more balanced economic growth. But with central banks like the ECB, BOJ, BOE, RBA, and RBNZ already warning against the limits of monetary policies, market players are figuring out that it’s now time for the government to step up its game.
2. Politicians are testing the independence of central banks
Most central banks are quasi-independent in nature. If they aren’t, then vote-hungry politicians would likely continue stimulating the economy even as it overheats. But now that pressure to see results from both governments and central banks are higher, the lines between fiscal and monetary policies are getting blurred.
In the U.S., for example, Trump has hinted that he wants to replace Janet Yellen as Fed head honcho while the Republicans have called for more scrutiny of the Fed’s actions. Meanwhile, the BOE is in hot water for warning against a Brexit and possibly restarting QE too soon. Heck, even ECB’s Mario Draghi is on the defensive against Germany for not giving up its expansionary stance!
3. Politics influences other market movers
As we’ve detailed in our School of Pipsology lesson, factors such as capital flows, trade balance, and leadership also influence currency price action. And you know what influences all three? Yep, you guessed it: politics.
When people feel confident about an economy, they pour money into it in the form of capital investments which adds to the demand for a currency. But if they aren’t certain about an economy’s future – as they currently are with Britain’s plans to leave the EU – then they tend to delay or even withdraw their plans to invest, which then delays moolah flowing into the economy.
The same goes for a country’s trade flows. Talks of protectionism and devaluing currencies greatly affect trading activities, and could directly factor in computing overall economic growth.
Last but not the least, politics influences the stability of financial markets. Trump’s tax and deregulation plans, for example, have been welcomed by Wall Street with open arms and has led to market rallies across the globe. Alternatively, any hints of weaknesses in the government or conflicts with other global leaders tend to sow uncertainty in the markets.
4. Investors don’t like uncertainty
Change in leadership is nothing new in the forex scene, of course. But the rise (and success) of populist, anti-establishment campaigns, as well as the speed of which the new leaders execute their typically “unpresidented” plans expose market players to uncertainty.
Even central banks are being forced to adjust. FOMC members, for starters, are generally tempering their hawkish biases until they learn more about Trump’s economic policies. Meanwhile, the BOE has not only abandoned its hawkish stance, but it was also forced to restart its asset purchasing program in the wake of the EU referendum.
That’s it for my list today!
Though monetary policy has taken a back seat against politics, it doesn’t mean that major central banks won’t go back under the spotlight. After all, sound fiscal AND monetary policies are needed to attain balanced and sustained economic growth. Once the new batch of global leaders have shared their plans, it’s likely that our favorite central bank heads will make headlines again.