I received back to back questions on dovish and hawkish trading, and I decided I ought to write something about them.
The questions were not necessarily centered on dovish vs hawkish trading. There were some that were asked independently, like “what does hawkish mean in forex,” “what does dovish mean,” and “what is hawkish in forex” among others.
Maybe you might be having these questions too? Don’t worry; I will elaborate on them.
You may have heard a financial news presenter talk of something along the lines of “after a slew of positive economic results, the governor of the central bank came out marginally more hawkish today.”
Hawkish and Dovish are terms used to refer to whether it’s more likely for central banks to accommodate (dovish) or tighten (hawkish) their monetary policy.
Policymakers at Central Bank weigh whether to increase or decrease interest rates, as the rates have a great influence on the forex market.
They increase interest rates so as to prevent the economy inflation from going very high and decrease interest rates to prevent economic deflation and stimulate GDP growth.
Hawkish and dovish policies impact currency rates via mechanism central bankers prefer to call “forward guidance”.
Through this, policy makers strive to be as transparent as they can in their communications to the market concerning where monetary policy may be moving to.
In a hawkish situation where interest rates are rising, money borrowing by both businesses and consumers tends to be more expensive because of the higher interest repayments, and this, therefore, results in a decrease in spending and investment.
On the other hand, the Dovish monetary policy is the opposite.
With a dovish scenario where interest rates are falling, money is made cheaper and easier to access for businesses and consumers, and this encourages them to invest well or spend.
From this spending by businesses and consumers, a stagnant economy is stimulated.
Difference between hawkish and dovish monetary policy
Dovish Monetary Policy
Hawkish Monetary Policy
|Dovish monetary policy is used so as to push inflation closer to the central bank’s inflation target rate.
The policy supports inflation and is used when consumer prices fail to rise.
|Hawkish monetary policy is normally targeted when there is high inflation.
The term is used in fighting inflation when it begins to rise past the central bank’s target rate.
|This monetary policy is also used when the central bank sees that the economy is slowing or that the levels of unemployment are high.
Dovish monetary policy focuses on supporting the economy that is slowing and could potentially end up in a recession.
|Hawkish monetary policy on its part is also used when the central bank finds the economy to be growing strongly and risks “overheating”.
This could possibly lead to a recession and as a result, the central bank through this monetary policy is able to cool the economy from overheating.
|Dovish monetary policy is not very suitable for the currency as it leads to the exchange rate decreasing in value.
|Hawkish monetary policy on the other hand is more suitable for the currency as it increases in value.
Meaning of Dovish and Hawkish Trading
I have so far, in this post, explained how central bank monetary policy meetings can be distinguished between dovish or hawkish.
In regard to the way markets think of the central bank’s statement, the currency markets will normally react accordingly.
Among the main factors to have in mind is that the markets are normally forward-looking. Therefore, even prior to holding of the central bank meeting, the markets normally move in a particular direction hoping for a certain outcome from the central bank.
From this, we derive the commonly used phrase of ‘buy the rumor, sell the fact’.
The markets place themselves ready as they wait for the result of the central bank meeting. Following the meeting, however, depending on the outcome, the market can react differently.
While reviewing the meaning of hawkish or dovish in the forex markets, therefore, it is generally about the expectations.
The markets already discount the expectations and are in anticipation of the real outcome of the meeting.
Therefore, if you happen to hear that a central bank was dovish than expected or hawkish than expected, it may result in a strong market reaction.
It is basically good for the currency in question when a central bank is hawkish. On the other hand, when a central bank is dovish, it is not good for the currency in question.
In an example, should the U.S. Federal Reserve come out hawkish than estimated, then the USD would appreciate. Or when the European Central Bank comes out dovish than projected, then the EUR would decrease in value.
This is something that would give a trader an idea of how to approach the EURUSD pair.
How do they Impact Prices in Forex?
When interest rates decrease or increase, it has numerous effects on the forex markets, as explained above.
So, currency traders and investors therefore pay keen attention to the information that the central banks issue over certain periods.
When the central bank decision in a country is hawkish, investors begin to place their money in the currency of that country, as they target to benefit from the high interest rates that the country’s market gives.
Hawkish doesn’t mean that the currency will strengthen instantly; it is, however a sign that the possibilities of it strengthening are high. With this, hawkish trading is assumed to be a safe bet.
When the central bank decision in a country is dovish, forex traders and investors begin to sell the currency of that country because they expect the currency to decrease in value.
International trade is also affected since the costs of goods and services from this country will decrease at a global level. This results in increased demand from global countries.
It is, however very important for forex traders and investors to pay close attention to the way low interest rates go.
This is because if the rates still remain higher than the rates of other countries, it would probably signify that there will be no great changes in the value of the given country’s currency.
I hope now you have a better understanding of how dovish and hawkish trading works.