On 28 July, the US Federal Open Market Committee (FOMC) will meet to discuss monetary policy, and inevitably, its taper timeline for the pace of bond purchases. In the days that follow, traders should expect a flurry of market activity.
“Why?”, some traders and investors may ask. The simple answer is this: any comments or statements following central bank meetings offer a strong indication of market sentiment and economic strength, not to mention insight into policies and planned activities. Naturally, the markets react in turn.
Minutes from the last FOMC meeting, for example, revealed that the Fed was moving towards tapering its asset purchases sooner than initially thought – implying that the economy was faring better than expected. Consequently, it was no coincidence that the dollar traded at near its highest level in three months.
Traders would do well to take note of the fact that statements like these from central banks have the ability to spark rallies, or send stocks plummeting, depending on what is discussed. Particularly as the Covid-19 situation continues to evolve, central banks around the world will be continuously re-evaluating monetary policy, and traders should monitor these events closely.
Getting to grips with market fundamentals
For some traders and investors, it might be beneficial to first revisit market fundamentals to gain a better understanding of what moves the markets. Where central bank statements are concerned, it can be useful to focus on the key indicators set out by each bank – specifically, production, employment, growth, and inflation figures.
The most important indicator to watch out for is typically inflation – the rate of inflation can have a strong effect on the base interest rate set by central banks, which, in turn, can impact the value of local currencies. For example, if interest rates are heading lower, it is more than likely that currency rates will, too.
It is important to acknowledge that a central bank will seldom make any drastic changes to interest rates out of the blue – typically, traders can expect the banks to hint at this long before any alterations come into place. That said, even the slightest suggestion that a rate rise is on the way will drive local currencies higher, buoying the market – a sure sign of a strong economy. Likewise, investors can potentially obtain higher investment yields from their investments with the bank in these scenarios.
Language is key
With the basics in mind, it can often be tempting for traders and investors to put off reading a full statement from the Bank of England (BoE), say, in favour of a shorter, line-by-line precis. However, these bullet-pointed summaries can sometimes miss the mark – glazing over an important phrase that sets the tone for the markets, or failing to provide adequate context for a vital policy change.
As such, traders should get into the habit of reading these documents in full in order to see the bigger picture of what is happening in global economics. More often than not, by following these statements closely, traders will find that important comments can sometimes be hidden within the details. Indeed, a phrase that might not immediately stand-out can sometimes go on to become relevant at a later date.
Another factor to bear in mind is that the language used by central banks can often be of equal – if not greater – relevance than numbers and statistics. A good example of where the tone of a statement had a major impact on the movement of currencies was the Bank of England’s Dr Gertjan Vlieghe’s recent comments that an earlier rate rise would be appropriate, given that he anticipated the UK would transition more smoothly out of the furlough scheme than initially thought.
As these comments contrasted sharply with Vlieghe’s usually more dovish tone, offering a bolder and more hawkish perspective, what followed was a strong run higher in GBP. Indeed, traders should monitor the perspectives of more neutral figures, for any shifts in outlook, in addition to monitoring for the release of employment figures and inflation.
Other central figures from the BoE have the ability to sway the markets, too. Take for example interest-rate setter Michael Saunders, who spoke more like a hawk than usual during his July 15 speech, as he hinted at a sooner than expected tightening of monetary policy. This resulted in a boost to the near-term strength of GBP.
Although statements and comments from central banks may seem abstruse initially, traders and investors will no doubt become more sensitive to the nuances and subtleties of these documents over time – and this is a very valuable skill indeed.
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Giles Coghlan is Chief Currency Analyst, HYCM – an online provider of forex and Contracts for Difference (CFDs) trading services for both retail and institutional traders. HYCM is regulated by the internationally recognized financial regulator FCA. HYCM is backed by the Henyep Capital Markets Group established in 1977 with investments in property, financial services, charity, and education. The Group via its relevant subsidiaries have representations in Hong Kong, United Kingdom, Dubai, and Cyprus.