The Fed is dovish.
Wait…what does that mean again?
Are they raising interest rates or lowering them? Does that mean that the US dollar will go up or down?
I used to get confused by the terms hawkish and dovish. Both with the meanings and more importantly, how each monetary policy can affect the value of a country’s currency.
But whenever you read something about monetary policy, it’s usually in geek-speak and it takes a few minutes to digest the real meaning and real-life application of the terms.
Want some plain English?
In this post, I’ll give you the trader’s definition of both hawkish and dovish, and show you two easy mnemonics that you can use to remember them in the future.
Remember that there are a lot of factors in play in a nation’s economy. So while I’m going to make this as easy to understand as possible, the effect of monetary policy on a nation’s economy is never black and white.
This is a post in our Forex Education series.
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Introduction to Hawkish and Dovish Monetary Policy
Hawkish and dovish are terms that refer to the general sentiment of the central bank of any country, or anyone talking about a country’s monetary policy.
They are not concrete, in the way that the Nonfarm Payrolls (NFP) number was 255,000 this week.
It is simply a way to refer to an overall outlook, and opinions will vary…greatly.
Some people may think that the ECB (European Central Bank) is dovish, while others may think that it is hawkish.
To make things more interesting, the hawkishness or dovishness usually has to be read “between the lines.” A central bank will not come out and say:
“We will be hawkish for exactly three months, starting…now!”
OK, they might. But you will usually have to infer that from their public statements.
But then they could change their mind tomorrow.
…or they could be straight-up lying.
Keeping that in mind, let’s get into the definitions…
Definition of Hawkish
A hawkish stance is when a central bank wants to guard against excessive inflation.
I’m sure that you understand the simple definition of inflation, which is: the overall price of goods and services increases.
Inflation happens when the economy is growing. This leads to an increase in wages and/or the cost of raw products. This could happen for a variety of reasons, some of which you can read about in detail here.
Obviously, if everyday goods and services good too expensive, too quickly, people will be unable or unwilling to buy things. This prevents money from changing hands and slows down the economy.
Central banks don’t want the economy to grow too quickly, because it is not sustainable.
So they try to keep the economy growing at more reasonable pace by being hawkish, or watching over inflation. They usually do this by raising interest rates.
When money becomes more expensive to borrow, it slows the growth of the economy because it makes it harder for businesses to grow by using borrowed money to expand, and people will spend less through borrowed money, like credit cards.
How a Hawkish Monetary Policy Affects Forex Traders (in theory)
When interest rates increase, that will usually cause the value of a currency to rise.
No surprise here.
International investors will move their money to a place where they can get higher interest rates.
You would do the same thing, right?
It’s like if Bank A paid an annual 1% interest on their savings accounts, but Bank B paid 4% per year. You would probably move your money to Bank B to get the extra 3%.
Keep in mind that just because a central bank increases interest rates, that does not mean that a currency will automatically rise in value.
There are many complex factors at play in a national economy.
It can also depend on the amount of the increase, the post-increase rate relative to other countries and if the increase was expected or not.
But if you want to keep things really simple, a hawkish stance can be a clue that interest rates may increase and thus, the value of the currency might increase too.
Remembering the Definition of Hawkish
If you are having trouble remembering which is which, remember that hawks fly much higher than doves.
So everything hawkish has to do with things going up:
- A hawkish stance is guarding against inflation getting too high. Think about a hawk circling to protecting the upper limit of inflation.
- To curb inflation, a hawkish policy will increase interest rates, or some other equivalent action.
- An increase in interest rates can cause an increase (strengthening) in the country’s currency.
Definition of Dovish
Dovish is the opposite of hawkish. This is when an economy is not growing and the government wants to guard agains deflation.
…which is a decrease in the cost of goods and services.
Learn more about deflation here.
In other words, they want to do something to stimulate the economy. In order for people to start spending more money on goods and services, the central bank will usually lower interest rates.
When it is easier (cheaper) to borrow money, businesses can expand more easily and consumers will usually spend more money by using credit cards or other types of debt, to finance purchases.
How a Dovish Monetary Policy Affects Traders (in theory)
So, as you probably know by now, a dovish monetary policy will lead to lower interest rates (or an equivalent action) and a possible weakening of the country’s currency.
Although a lower interest rate will usually weaken a currency, what also matters is the interest rate, relative to the interest rate of other countries.
If an interest rate is lowered, but it is still much higher than the interest rate of other countries, then the reduction probably won’t have a very big impact on the value of the country’s currency.
Remembering the Definition of Dovish
You usually see doves on the ground.
- When a central bank is dovish, they are guarding against deflation, or the cost of goods and services getting too low.
- Interest rates might be lowered
- If interest rates are lowered, then the value of a currency may decrease
Where to Get Monetary Policy Information
Now that you understand the two terms, it’s time to learn where to get this information. It would be nice if you could go to a website that told you the current bias of every central bank in the world.
But as I mentioned in the beginning, it’s not that easy. To understand if a central bank is hawkish or dovish…or neither, you have to read their public statements.
Here are the websites of the biggest central banks, to get you started.
- US Federal Reserve Monetary Policy Report (FOMC)
- European Central Bank (ECB)
- Swiss National Bank (SNB)
- Bank of Japan (BOJ)
- Reserve Bank of New Zealand (RBNZ)
- Bank of Canada (BOC)
- Bank of England (BOE)
- Reserve Bank of Australia (RBA)
At this point, you may be wondering where central bank interest rates fit into the overall picture of a nation’s economy.
This interest rate is the rate at which other banks in a country can borrow money from the country’s central bank.
For example, in the United States, the central bank is the Federal Reserve. The central bank interest rate determines the rate at which other banks like Chase can borrow from the Federal Reserve.
This has a “trickle down” effect and determines the rates of everything from savings account yields, to credit card interest rates, to mortgage rates.
See current central bank interest rates here.
If you were confused between hawkish and dovish before, I hope that this post cleared things up.
Still have more questions? Leave them in the comments below…