What does Hawkish mean? Here’s the short answer.
The meaning of the term hawkish is especially important to Forex traders, as it is critical to understanding the trends and developments in currency markets.
The moniker is derived from the predatory and unsympathetic nature of the hawk bird and is often used as a metaphor to describe the sentiment of a Central Bank.
Specifically, “hawkish” describes a Central Bank’s preferred stance towards monetary policy.
Hang on… what’s Monetary Policy?
Monetary policy is all about altering interest rates and the money supply to influence economic activity.
This is a topic of the upmost importance to Forex traders because interest rates are the single biggest factor that drives currency trends.
When a Central Bank is hawkish, it is less concerned with economic growth and more concerned with inflationary pressures within the economy. This simply means that the economy is heating up and the Central Bank would like things to slow down a little.
The Central Bank would thus be more inclined to raise interest rates and/or reduce the money supply, which is a process known as monetary ‘tightening’.
Hawkish vs Dovish
On the other hand, if a Central Bank thinks that the economy is slowing down too much, it will be inclined to be hold a dovish stance, and be more likely to loosen monetary policy.
By cutting interest rates and/or increasing the money supply, a dovish Central Bank tries to achieve the opposite effect: stimulate growth in the economy.
Remembering what Hawkish means
A simple way to remember what hawkish means is to consider the following hawkish and dovish concept: Hawks fly higher than doves and therefore hawkish sentiment corresponds to a Central Bank that is looking to push interest rates up.
In contrast, doves fly a lot lower than hawks. Hence, the term is used to describe Central Banks that are generally looking to lower interest rates.
A real-world example of a hawkish stance was taken recently by the Reserve Bank of New Zealand (RBNZ) when they ruled out further interest rate cuts and provided forward guidance for raising interest rates to prevent unwanted inflationary pressures in the economy.
Furthermore, the most hawkish central bank at present is the US Federal Reserve, which is set to deliver further rate increases in 2016. What does this mean for their currency (the U.S. dollar)?
It basically means that it is expected to appreciate.
As interest rates are raised, savers can now earn more in interest so overseas savers have a strong incentive to move their money into U.S. banks to enjoy the higher interest payments. This increases demand for the currency, causing it to appreciate.
How To Trade Hawkish Expectations
In Forex trading, the best way to capitalise on such sentiment is to identify a Central Bank that’s hawkish (e.g. U.S. Federal Reserve) and then identify a Central Bank that is dovish (e.g. Bank of Japan). In this instance, the way to trade is to buy USD/JPY currency pair.
One key thing to be aware of is whether or not markets have priced in the expected future path of monetary policy.
The element of surprise can be a useful tool for Central Banks as their policy announcements may have little effect if they have already been expected by the market at large.
So as a Forex trader, it helps to anticipate the market expectations of future Central Bank sentiment.
The question to ask is: have the currency markets discounted the future actions and sentiment of the Central Bank? If traders have not fully priced it in, then there exists a trading opportunity for you to capitalise on.
For example, when the RBNZ made the announcement that interest rates would not go any lower, this caught many Forex traders by surprise.
This unanticipated switch to a hawkish stance (from a dovish one) caught people off guard, causing the New Zealand Dollar appreciate sharply following the announcement.
If this had been anticipated beforehand, the news would have had little immediate effect on the value of the New Zealand Dollar.
Hawkish = Tighter monetary policy
In summary, hawkish refers to the higher probability that monetary policy will be tightened by the Central Bank, which in theory, would lead to an appreciation of the currency.
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The Economist, Is Janet Yellen a Dove or a Hawk?
Babypips, Hawkish and Dovish central banks
Investopedia, Definition of a hawk
Moneyshow, How to trade a dovish or hawkish central bank