In my opinion, monetary policy is largely a fiat matter – meaning a central banker can, if determined enough, expand or contract the money supply as they please. If the money supply is expanding, it is reasonable to expect prices to rise, and a bubble could possibly form in a given region. If the money supply is shrinking, we can expect prices to drop, and a given sector may decline. Which sector will bubble and collapse depends on other economic factors.
Because monetary policy is largely dependent on the wishes of central bankers, understanding the psychology of central bankers is extremely important. In terms of what news to pay attention to, news that tells whether central bankers want inflation or deflation, and how determined they are to reach their objectives, is especially important. It is also worth looking at whether free market forces are in consonance with or in opposition to the objectives of the central banker. If there is resistance, we must ask ourselves whether central bankers are determined enough to harness free market forces and create monetary policy as they wish. For example, over the past several decades, the Bank of Japan has been trying to create a weak currency, but has been unable to do so due to market forces.
Whether or not central bankers are achieving their desired results can largely be seen through exchange rates as well as official money supply indicators. For this reason, monitoring changes in the money supply can be a very useful tool for traders in understanding how the economy is changing, and whether central bank objectives are being achieved. Central banks usually report changes in the money supply on their respective web sites on a regular basis.
In addition to money supply indicators, traders should definitely watch the interest rate targets announced by central banks. As a general rule of thumb, higher interest rates lead to stronger currencies, as investors will invest in currencies that give them a higher rate of return.
By understanding the desired policy of central bankers and seeing how successful they are at implementing this policy, the trader can best understand how capital is moving within an economy – which in turn can identify profitable trading opportunities. and enable them to be capitalised.