Economic & financial risk insights: financial stability risks rising as liquidity tide goes out. Bond markets are taking flight from fiscal and monetary inconsistencies, exposing financial stability risk. The UK government, under new prime minister Truss, announced larger-than-expected tax cuts and a costly energy price guarantee last month. A sharp sell-off in long-maturity gilts followed, triggering margin calls on pension funds leveraged derivative trades that required Bank of England (BoE) bond-buying to prevent a vicious spiral and systemic financial stability crisis. Since then, government U-turns suggest less aggressive BoE rate hikes than if the original budget had gone through. With a looming winter energy crisis across Europe, we anticipate more fiscal relief from various governments. But with bond investors now questioning debt sustainability in the new interest rate reality, fresh borrowing on top of already high public debt will carry higher interest. This will complicate central banks' monetary tightening efforts and make them more politically sensitive. In the US, the still-strong labour market and sticky core inflation means we now forecast an above-consensus terminal rate of 5.125% next year. We also do not expect the Fed to cut interest rates despite a likely US recession in 2023, as it will take longer for elevated and broad-based inflation to move back to target. Hence, we raise our 10-year US Treasury yield forecast for 2022 to 3.9% and to 3.6% for 2023. TINA is back: "there is no alternative" to the US dollar. Despite high inflation, the USD has strengthened significantly this year. For other economies this has meant currency depreciation, capital outflows, tighter financial conditions, and also higher inflation when imports are priced in USD, creating a tricky trade-off for monetary policy. Japan and China recently intervened to shore up their currencies, but the effect may be short-lived given interest rate differentials. If prolonged dollar strength forces emerging market central banks to raise interest rates to support their currencies, a synchronised global recession becomes likely, and risks eventually spilling back to the US. QUESTION ONE (20 Marks) Read the article above and write an essay that discusses the factors that contribute to liquidity in financial markets. QUESTION TWO (10 Marks) Derivatives are important instruments that are used extensively in portfolio management. Critically evaluate the ability of derivatives to create a more efficient, complete and productive economy.