Wednesday , 30 November 2022

Economic Recovery and Monetary Policy Tightening

This world hasn’t declared the end of pandemic, but with the rollout of the vaccination rate, for sure economic recovery is on the way. As per the theory of the economic cycle, in the early recovery phase, some central banks will (or have been) unwind their economic stimulus. We have seen some central banks withdraw their liquidity (stop or reduce) the QE activity, even some of them have raised their interest rate.

As part of fundamental analysis, forex trading activity shall consider central bank monetary policy and action as part of their analysis since monetary policy is one of the biggest factors of currency value direction. Analyzing central bank speech, monetary policy statement, board member statement, or central bank’s key opinion leaders statement should help traders to identify central bank view, insight, forecast, or even the action regarding the liquidity or interest rates. If the key message stated explicitly, it is pretty straightforward that traders could analyze their key points such as tone, forecast, interest rate decision, or liquidity (QE) action. Tone which includes but is not limited to economic data forecast and key interest rates decision information could be extracted explicitly from the MoM, speech, and/or related statement. But what about the QE (liquidity) action? Mostly they explicitly state the tapering or the QE amount and traders could try to calculate it quantitatively. In this article, we will try to analyze the central bank liquidity action (increasing or reducing) through the central bank balance sheet data quantitatively. Remember that the market is not focused on the absolute level of the fundamentals. Instead, the market focuses on the delta or the changes. In order to analyze the delta or changes, we will use the central bank balance sheet and Money Supply M1 data, and normalize it in percent (%) changes.

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From table 1, we could see that all of the central banks have the same pattern. All of them have a value of change that is getting smaller from week to week. However, if we take a look deeper, we see that the changes in the decline in the balance sheet of some banks are not really smooth, particularly USD (FED), GBP (BoE), and AUD (RBA). Whilst from table 2, we could see that the changes in the decline of the money supply in last 2 month for EUR (ECB), GBP (BoE), CAD (BoC), CHF (SNB), and JPY (BOC) is quite small relatively compared with the other.

If we try to analyze and conclude from liquidity (M1 money supply and central bank balance sheet), we could expect that CAD, CHF, and JPY have probability to strengthen compared to other currencies. As a result, we could put this liquidity consideration as part of our fundamental analysis bias on the following week and/or month.

Of course this parameter could not be used as a single source of reference for trading. Fundamental, sentiment, and technical analysis shall be aligned properly in order to obtain high probability trade. But for sure, liquidity (M1 money supply and central bank balance sheet) could be used as one of the data points to identify currency direction.

Happy trade and remember, prioritize risk management over profitability. It is better to lose opportunity, than to lose equity.

Glori Kapital Indonesia

About Reza Aswin

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