The Impact of Central Bank Speeches on the Forex Market
As an integrated part of the forward guiding process, the way a central bank decides to communicate with markets depends on various factors. Central bank speeches are part of this communication process, and they differ from one central bank’s jurisdiction to another. Speeches that influence markets are not only those held by presidents or governors of central banks; other representative members in the overall governing body of a central bank hold regular press conferences, or participate in events where they talk about the state of the economy. Markets listen and react, with the retail traders following what the algorithmic trading, or high-frequency trading, or quant trading, is doing. This is the reality of this century: Humans follow robots – at least when it comes to trading in general, and to Forex trading in particular.
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Types of Speeches
A speech is when a central banker states his/her point of view regarding the monetary policy, or answers questions in a debate panel, etc. From this viewpoint, there are different types of speeches central bankers hold, and they are all equally important. Newspapers interviews, TV interviews, etc., fall into the same category when it comes to fundamental news from a central bank that influences the way the market is moving. Below are the most important types of speeches one can expect when trading the Forex markets.
Speeches Held by Central Bank Heads
These are by far the most important ones, and the ones that make Forex markets tremble. Forex traders focus on these speeches, and most of the time the whole forex dashboard stays in tight ranges until the central banker starts the speech. From that moment on, all hell breaks loose, in the sense that violent reactions are expected because algorithmic trading always makes the first move. Only after the dust is settled is it recommended for trading to start for the retail traders. Speeches by heads of central banks that have the tendency to influence the whole Forex dashboard are, in the order of their importance, the following:
- Speeches held by the head of the Federal Reserve of the United States (Fed). The Fed is the most important central bank in the world as it sets the monetary policy for the US dollar, which, in turn, is the world’s reserve currency.
- Speeches held by the head of the European Central Bank (ECB). The ECB president holds regular speeches in front of the press representatives as well as in front of the European Parliament, and the whole market is influenced.
- Speeches held by leaders of other important central banks: Bank of England’s Governor, Swiss National Bank’s President, Bank of Japan’s Governor, Reserve Bank of Australia’s Governor, and Reserve Bank of New Zealand’s Governors.
The central banks mentioned above are only the most important ones, but any currency pair you might trade is influenced by the leader of the central bank that represents it. Therefore, knowing when these speeches are to be expected is key to the overall positioning.
Speeches Given by Other Members of a Central Bank
Central banks are organised in such a way that interest rate decisions and the monetary policy, in general, are taken by consensus. When the central bank meets every month or every 6 weeks, as is the case for the most important ones, the governing body takes 2 days to analyse the economy. This means that, for those 2 days, central bank members look over the last economic indicators that were released since the last meeting; they analyse them, and see what has changed. If anything has changed, they will react through new monetary policy tools. The governing bodies of a central bank have different names depending on the jurisdiction, but essentially they all do the same thing. In the United States it is the Federal Open Market Committee (FOMC), in the European Union the Governing Council, in the United Kingdom the Monetary Policy Committee (MPC), and the list goes on. The role of the other members of a central bank, basically the members who are part of these governing bodies, is much more extensive than the above description. Their part is also to make sure the market understands the statement the central bank is issuing. To do that, in between central bank meetings, members of the governing bodies participate in all kind of interviews, speeches, conferences, etc., with the purpose of reinforcing the monetary policy stance.
It happens that sometimes markets get ahead of themselves, at least when it comes to the way they react to the monetary policy statements. If this is the case, these central bankers will talk the market the other way. To give you an example, let’s assume the Fed is hiking the rates and the US dollar is bought as a consequence. If the move is much more aggressive than was forecasted by the central bank’s projections, then the Fed members will have mentioned something dovish in their next speeches. It could be that they are going to state that the current economic momentum is temporary and not expected to stay, or that the monetary policy is still being viewed as a flexible tool; or, if nothing else works, they will simply use blunt language. However, there’s a catch to whatever a central banker is saying! The catch is that these guys must use a special kind of language when addressing the economic situation. One cannot bluntly say that the central bank is selling a specific currency, or something along these lines, because this would create disruptions in the way the financial markets function. Keep in mind that not only is the Forex market influenced by a central bank’s decision, but the stock market as well, not to mention the bond market and the regular options markets.
At the end of the day, all markets are interconnected, and the reaction to an unprepared speech may have a domino effect on the overall trading arena, and on the global economy as well. This is why central bankers’ speeches are so important, and why market participants listen to them with such interest. Moving forward, we’ll discuss what risk-off and risk-on trading environments are, and how traders can profit from knowing how these trading situations can occur.
Other educational materials
- The Importance of Press Conferences
- Risk-off vs. Risk-on Trading
- Macroeconomics in Forex Trading
- Forex Market Terminology
- Profit from Forex Trading Using Different Trading Styles
- How to Set Up an Expert Advisor
Recommended further readings
- “Central bankers and uncertainty.” Goodhart, Charles. Bank of England. Quarterly Bulletin 39, no. 1 (1999): 102.
- How do central banks talk? Blinder, A.S., 2001. . Centre for Economic Policy Research.