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How the forex market reacts as governments and central banks respond to geopolitical and economic stress Contd. 

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SCENARIO 3  

Monetary policy loosens, fiscal policy becomes tightens

During the early stages of the Great Recession, the Bank of Canada (BOC) reduced its benchmark interest rate from 1.50 percent to 0.25 percent in order to ease credit conditions, restore confidence, and stimulate economic growth. Contrary to popular belief, the yield on 10-year Canadian government bonds began to rise. This rally occurred at the same time that Canada’s benchmark TSX stock index reached a bottom. 

Investors’ shifting preference for riskier, higher-returning investments (like stocks) over comparatively safer alternatives was reflected in the subsequent restoration of confidence and recovery in share prices (like bonds). Despite the central bank’s monetary easing, this capital reallocation pushed yields higher.

The BOC then began to raise its policy interest rate once more, eventually raising it to 1%, where it remained for the next five years. 

Both CAD and local bond yields fell as monetary policy was eased while fiscal policy support capacity was limited. As it turned out, cutting government spending during a difficult time cost Mr Harper his job. Following his victory in the 2015 general election, Justin Trudeau took over as Prime Minister.

SCENARIO 4 

Monetary policy tightens fiscal policy becomes loosens 

The political landscape and economic backdrop favoured a bullish outlook for the US Dollar after Donald Trump was declared the winner of the 2016 US presidential election. With the Republican Party controlling the White House and both houses of Congress, markets appeared to conclude that the scope for political volatility had been reduced. 

As a result, the market-friendly fiscal measures proposed by candidate Trump during the election appeared to have a better chance of being implemented. Tax cuts, deregulation, and infrastructure development were among them. For the time being, investors appeared to disregard threats to launch trade wars against major trading partners such as China and the Eurozone.

On the monetary front, central bank officials raised rates at the end of 2016 and planned to raise them again by at least 75 basis points in 2017.

Conclusion 

Numerous studies have found that a significant drop in living standards as a result of war or a severe recession increases voters’ proclivity to take radical positions on the political spectrum. As a result, people are more likely to abandon market-friendly policies such as capital integration and trade liberalisation in favour of measures that are detrimentally inward-looking and turn away from globalisation. 

Because the modern globalised economy is so interconnected, both politically and economically, any systemic shock has a high probability of reverberating around the world. During times of significant political volatility and inter-continental ideological shifts, it is critical to keep an eye on these developments because they contain opportunities to develop short, medium, and long-term trading strategies.

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