The Hawks VS Doves battle is eternal. When it comes to the fate of a currency, the winner takes all.
But what are the differences?
And are we talking about here, since it isn’t about actual animals?
Discover this powerful Forex fundamental analysis concept below.
But first, some necessary context:
If you’ve read, heard, or participated in the markets, in any shape or form, then you know what bulls and bears are.
I’ll briefly describe them here.
Market participants are said to be bullish when they expect (and bet) asset prices will rise.
Thus, we associate bulls with long positions.
Bulls go long.
On the other hand, bears believe (and bet) asset prices will fall.
Hence, bears are associated with short positions.
When we say markets are bullish, it means most market participants (or the majority of $) is going long.
The reverse is true when we say markets are bearish.
In FX markets, the same is true.
As you probably know (or can imagine), the battle between bears and bulls rages on all the time.
And the winner dictates where price goes.
Thus, if there are more bulls than bears in the fight, price moves up until the numbers become more equal (it’s not the number of participants, but the $ amounts being bet).
Ok, ok… But what does this have to do with Hawks and Doves?
FX traders pay attention to the battle between Hawks and Doves before deciding to enter a position.
Let me explain:
When we talk of trading currencies, foreign exchange, forex, or FX markets (all the same), the most important market movers (beyond traders themselves) are Central Banks.
In FX, market participants can be bullish or dovish.
But Central bankers are said to be hawkish or dovish.
Hawks are Central bankers who lean towards hiking rates.
Doves are Central bankers who lean towards cutting rates.
Every Central Bank has the mandate to maintain price stability (though some, like the FED or the RBA have more than one mandate).
To curb inflation from getting out of hand, Central Banks often need to raise (hike) interest rates.
But if inflation is too low, and economic activity needs a boost, a Central Bank may need to cut interest rates (to boost both growth and inflation).
Interest rates move currency prices (exchange rate).
Therefore, when a Central Bank’s monetary policy makers convene to decide on what to do with rates…
FX traders watch closely.
Because this is when hawks VS doves battle takes place.
And the winners decide what to do with interest rates, and thus, where currency price will go next.
In practice, rate decisions come down to changing or not changing rates since most Central Banks offer forward guidance (they clue the markets on purpose, on what their decision will most likely be).
Thus, there are two basic scenarios for every rate decision:
Bank is considering hiking rates (it may hike, or it may leave rates unchanged).
Bank is considering cutting rates (it may cut, or it may leave rates unchanged).
As such, you never have a time when rates are expected to go up, but the Bank decides to cut… Or the other way around.
Let’s give an example.
Assume inflation has been running hot lately, and a Central Bank is considering hiking rates.
If hawks win, the Central Bank raises interest rates, the currency goes up against others.
On the other hand, if doves win, the Central Bank leaves rates unchanged, and the currency will either:
1. Devalue momentarily, and the move retraces (if decision was expected and it doesn’t alter expectations of what’s to come); or
2. Devalue sharply and more permanently (if decision wasn’t expected)
Number 2’s effect is much stronger if the Bank signals it is no longer as hawkish as it previously felt.
You can easily imagine how this would play out if we were speaking of a potential rate cut decision (just the opposite effects).
Note: While most Central Banks offer forward guidance, some, like the Swiss National Bank (SNB) don’t. So they can surprise the markets sometimes.
And that’s how we get to the bottom of it. To summarize:
If a Central Bank is more hawkish, its currency will gain.
More dovishness makes the currency go down.
This happens because the direction of interest rates directly influences currency price against others.
Lower rates, lower currency.
Higher rates, higher currency.
Hence, FX bulls and bears pay close attention to Hawks VS Doves encounters.
See you soon,
The Forex Economist
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