Hawks and Doves

From Volatility.RED

Now we are going to look at the individual central bank members' stances. That’s right, not all central bankers within a particular central bank will want the same thing when it comes to monetary policies. This means that some may prefer to have higher interest rates and other members will prefer lower interest rates and they are called Hawks and Doves. The differences in those opinions are what we are going to discuss next.


Hawks and Doves

Central Bank Member Speeches

Any public speeches or comments made by board members of central banks will be very important to the Forex market. This is because these members actually have an active say on what the future monetary policy of the central bank should be.

This highlights why FX traders obsess over central bank member speeches and why those speeches can have a significant impact on the value of their currency as they happen.

If a central banker says something important then traders need to appreciate that they might actually go ahead and implement their thoughts into the economy which will definitely have a certain degree of impact on the respective currency. The Forex market is always looking for clues as to which direction monetary policy is heading.


Central Bankers are Not Created Equal

Some central bank members will be more important to the markets than others. What do we mean by this statement?

Well, for example, for the FOMC not all members will have voting rights in a particular year. This means that there are more FOMC members than there are members that actually have a say at the table and can vote on the future of monetary policy.

A particular central banker can propose policy changes all they want but if they don’t have voting rights then they don’t actually have much of a say do they? What they say will obviously be important because they are on the inside and have access to information that we simply do not.

However, the market impact will always be far less for non-voters than for voters because non-voters just don’t have the same pull to actually cause change. So the markets will give more weight to the members that actually have a vote in the current year because someone with a vote obviously has far more say in the final outcome than someone who does not have a vote.

Along with this voting power, each central bank member has what is called a bias or a stance. What this means is that this particular person favors a one type of monetary policy over another. Some of them prefer to keep interest rates low while others believe that interest rates should be higher to benefit the economy. It's pretty uncommon for all members within a central bank to have the exact same stance because people just can’t ever agree on anything most of the time.


Hawks

Central bank members that prefer higher interest rates are called “Hawks”. This means that they think the economy is performing a little too strong and interest rates should rise to keep inflation in check. Each central banker has pretty strong opinions on how inflation is impacting the economy and this is why the market separates them with these naming conventions of hawks and doves.

Some central bank members are also known as a “Soft Hawk”. This means that they are happy with the way that the economy is performing but they do not necessarily think that the economy is overheating. Everything is performing well in their view and they do not think that interest rates need to be higher in the “Immediate” future. But, if you had to pull a soft hawk's arm they would say that interest rates should rise gradually over time. They certainly would not speak of lowering interest rates.

The major difference between a hawk and a soft hawk is basically how immediately they think interest rates should rise. Hawks want it as soon as possible and soft hawks are happy for interest rates to rise gradually over time. Either way, they agree that interest rates are better at higher levels and should not be going down.


Doves

Doves are just the opposite of hawks.

Central bank members that prefer low-interest rates are called “Doves”. This means they think the economy is in such a state that it needs a boost or stimulation of some kind. Basically, they want to become or remain “Accommodative” to the economy to help get it running at a higher capacity as soon as possible. Accommodative simply means that they want to do things for the economy that will increase business activities and spur inflation.

Because of the great financial recession that kicked off in 2007 most major central banks have been accommodative for a long time and are running at really low-interest rates. This is a situation where almost all major economies have been running at historically low-interest rates and it is yet to be determined how these economies will react when interest rates start to rise to historically normal levels.

Low-interest rates are intended to promote borrowing and spending within an economy with the hopes that inflation will pick up and move toward the central bank’s desired target. The target is typically around 2% inflation per year.

Some central bank members are also known as a “Soft Dove”. This means that they are not necessarily happy with the way that the economy is performing but they do not think that the economy needs to be excessively stimulated. They don’t think the economy is performing overly well but they do not think that interest rates need to be lower in the “Immediate” future. If you had to pull a soft dove's arm they would say that interest rates should be lowered gradually over time.

The major difference between a dove and a soft dove is basically how immediately they think interest rates should be lowered. Doves prefer lower interest rates as soon as possible and soft doves are happy for interest rates to decline slowly over time. Either way, they agree that interest rates are better at lower levels and not at higher levels.


What is a Centrist (Neutral)?

There is also a neutral stance on interest rates. Central bank members with this neutral stance are referred to as “Centrists”.

Basically, these members are overall happy that the economy is performing well enough that there is no need to change interest rate policy in the short to medium term. They are typically in the thought camp of “let’s wait and see” how the economic data is performing within their nation. They simply need the economic data to turn one way or the other before they would look to change their stance or for changes in monetary policy.

Over time these members could go either way based on changes in the economic trends. These members are typically the most flexible.

The market would find it very interesting if a centrist started talking overly positively or negatively about interest rates. When this situation happens the market is going to think that there must be a very compelling case for the centrist to be changing their tone from neutral to positive or negative. This is the kind of event that could really move the price of the currency in question because the centrist obviously knows some key information that we do not and that makes the market very interested to learn more.


Why Traders Care about Hawks and Doves

Well, that’s a great question. Traders trade because they want to make money, like it’s really the ultimate reason we trade or want to become a trader right?

The key to profiting from knowing the differences between hawks and doves is looking out for comments from these central bank members that go against or are out of line from their traditional stance.

For example, if a central bank member that is traditionally known to be a hawk (pro high-interest rates) says something that is pro lowering interest rates (dovish), this could potentially be market-moving information.

On the flip side of that, if a central bank member that is traditionally known as a dove (pro low-interest rates) says something that is perceived to be pro higher interest rates (hawkish) then this could be market-moving information as well.

For example, if a hawk that is a voting member of a central bank delivered a speech and in that speech, they started talking about how concerned they are about the economy and that a rate cut would probably be a good idea soon, the market will react in a big way because this particular member is traditionally known as a hawk who prefers higher interest rates. So for that member to say something so far out of line with their traditional stance this means the case must be really strong to have lower interest rates. Remember, central bank members have access to information that we simply do not. If they are telling us something that is out of line from their normal position then this is a big deal to the Forex market.

There would be no reason for a known hawk to temporarily switch its stance to being dovish unless there was a very real reason and big concern to do so. These people don’t just flip-flop any old time they feel like; it’s a really big deal if they do. Remember, part of each central banker's mandate is to ensure the price stability of their nation’s currency so they are very careful in how they communicate to the market. Any central banker that became erratic in their stance would be ousted soon enough.

In this example, having information like this would make rate cuts far more likely to happen because this person has a vote and obviously has access to information that we do not. Let’s not call the central banker a liar here; let’s just do what we are told by the particular central banker and trade in line with the sentiment that would have been created by this event.

On the other hand, if a dove (pro low-interest rates) said something that the market perceives as being pro higher interest rates (hawkish) then this would be way out of line from their traditional stance. This could cause the market to start buying up their home currency because the Forex market loves higher interest rates. We also know that any market is a discounting mechanism that always tries to price in new information as quickly as possible.

The point is that these central bankers have access to information that we simply do not. So if they are saying something that is the opposite of their traditional stance then there must be a really strong reason for it. And traders need to pay attention to that reason and dig deeper to find out what has changed to make them change their stance.

It's most likely that you will see these central bank members' comments being streamed across news feeds. Most of the time these comments will be in line with their traditional stance and cause little market reaction. However, when you do see or hear a comment out of step with their usual stance then these can be great opportunities to trade the market’s reaction to this information.


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