The following is a guest blog post:
Investing is not for the faint of heart. This is true for beginners, intermediate-level investors, and experts. Part of the problem with the financial markets is that they are unpredictable. Fortunately, the more you know, the luckier you get with investing. This is not to say that the pundits can’t get it wrong, because they do. However, armed with the right knowledge you can certainly make more winning trades than losing trades with your broker. Financial trading experts at Saxon Trade have been pushing education as the single best investment resource for their clientèle.
According to esteemed investment consultant Montgomery H. Barkley, ‘Investing is not a willy-nilly activity like pinning a tail on a donkey at the local fair. It is part and parcel of a strategic decision-making process that encompasses extensive research, and analysis.’ Such sentiment can be a little disheartening to those without the requisite understanding of supply and demand, economic data analysis, technical and fundamental indicators. Fortunately, the factors that determine price movements in financial markets are not as complicated as institutional investors in ivory towers make them out to be.
Basic introduction to fiscal and monetary policy intervention in the economy
Financial data is pervasive. Anyone with a laptop, smart phone, or tablet can access the information at any time. The macroeconomic variables that shape financial markets are vested in two areas: fiscal policy and monetary policy. Fiscal policy determines how money is spent by the government. This includes investment spending and taxation. Investment spending injects cash into the economy and stimulates economic growth, while increased taxation removes cash from the economy and causes a contraction in economic growth. However, they are both part of the same cycle since the government needs the tax dollars to inject into the economy, unless it borrows the funds. Nonetheless, speculators use this type of fiscal data to formulate their analysis of stocks, currencies, commodities, and indices.
On the other side of the spectrum is monetary policy. This is controlled independently of the government by the central bank. The Fed is the chief central bank in the world, alongside other major central banks like the Bank of England, Bank of Japan and the European Central Bank. When the Fed decides to hike interest rates – the federal funds rate – these policy decisions reverberate globally. Part of the reason for this is that the USD is the world’s #1 reserve currency. Most of the globally traded assets are denominated in dollars, and so anything that raises the cost of the USD naturally affects the demand for dollar-denominated commodities like gold, crude oil, copper, steel and so forth.
How are the Fed’s actions impacting financial markets?
The Fed is now in a monetary tightening frame of mind. This means that it is raising interest rates to shore up the US economy which is burning red hot. With the unemployment rate currently at 4.4% and April jobs figures up 211,000, the Fed is moving full steam ahead. Monetary policy can work in conjunction with fiscal policy to achieve macroeconomic objectives, although the two typically act independently. In the US, Trump campaigned on the promise of massive fiscal stimulus with infrastructure growth and development. This sent stock markets into a frenzy. The risk-off approach to equities markets reversed and traders went full steam ahead into Wall Street. The S&P 500 index, the Dow Jones and the NASDAQ are all trading at or near record levels in anticipation of massive fiscal stimulus. As we know, the intentions of politicians hardly ever translate into tangible realities.
From a purely theoretical perspective, a federal funds rate interest rate hike will make foreigners more interested in buying the USD and selling foreign currency. As the dollar appreciates in value, so more people will be interested in acquiring it. This is not always the case however. The last time the Fed raised interest rates it didn’t have the desired effect on the USD. The reason being: the Fed never outlined plans for how many more rate Hikes they were going to implement in the FOMC speech that followed. For the most part, traders and speculators will factor rate hikes into currency markets and equities markets well ahead of time. When the actual decision is made, it often has a muted effect.