Recognise and interpret how economies are connected through growth, interest rates and currencies
The idea
Economies are linked through trade, capital flows and financial markets, so a forecast for one market must consider its partners. Macro linkages: a small open economy imports its partners' cycles, and a current account deficit must be financed by capital inflows. Interest rate linkages: under a currency peg, domestic rates are tied to the anchor country's rates plus a risk premium, and when the peg looks fragile the premium widens. Exchange rate linkages: covered interest parity ties forward rates to rate differentials, while real rate differentials, relative growth and risk appetite drive spot rates. Bond yields in open markets tend to move together. The trap is analysing a country in isolation or assuming a peg removes currency risk.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →More in Capital Market Expectations, Part 1: Framework and Macro Considerations
- Explain what capital market expectations contribute to managing a portfolio and set out a structured process for building them
- Set out the obstacles an analyst meets when producing forecasts for capital markets
- Explain the ways in which unexpected outside events can shift the long-run growth path of an economy
- Explain how an assessment of trend economic growth feeds into long-run forecasts for asset returns
- Contrast the principal methods used to forecast the economy
- Explain how the stage of the business cycle shapes return expectations over short and long horizons
- Explain how inflation behaves across the business cycle and what it means for returns on cash, bonds, equities and real estate
- Explain how central bank and government budget policy influence the course of the business cycle
- Read the yield curve's slope as a signal about the economy, and explain how it reflects the combined stance of monetary and fiscal policy