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2 Questions to Ask Before You Trade a Central Bank Rate Decision

2 Questions to Ask Before You Trade a Central Bank Rate Decision

Tyler Yell, CMT, Currency Strategist

Talking Points

  • Preparing For A Central Bank Rate Decision
  • The 2 Main Questions To Ask Yourself
  • Placing a Trade off the Print

2013 has been a year where Forex market pivots have been on the heels of Central Bank meetings. Nothing else can so abruptly change the direction a market is heading like a Central Bank. For example, last week the Federal Reserve simply implied that they’re not asnegative on the economy as many believed and that provided the USDOLLAR with its largest rally in months. This article will serve as a primer to walk you through approaching a Central Bank announcement as well as how to trade or adjust your position after the announcement has hit the wire.

Preparing For a Central Bank Rate Decision

Central banks are the key driver of the Forex market as they control the monetary policy that affects interest rates and sometimes open market operations to assist the economy. A simple understanding of a Central Bank’s chief tools and objectives will be instrumental in helping you gauge how to prepare and trade an upcoming Central Bank announcement. Once you have a clear understanding you can create a framework for trading an upcoming rate decision.

Two Questions to Ask Yourself When Approaching a Bank Rate Decision

The two questions that should help you to place a trade once a rate decision statement has been released are:

  • Where is the Central Bank Wanting the Economy to Go?
  • How Will They Use The Currency To Deliver That Result?

The first question will help you get your mind in line with the Central Bank’s objectives. This is key because you want to see if the statement is more or less aggressive in allowing them to reach their goals for the economy. You can take a simple example like the US Dollar whose Central Bank, the Fed, is working to expand employment as well as reach an inflation target of 2% to show as proof that the economy is recovering.

The second question is what most traders around the world are focused on for placing a trade on a currency pair. The answer to this question drives most Quantitative Easing efforts or other open market operations. Naturally, if a central bank feels that the economy is in such poor health that they must flood the market with the home currency to get the wheels of the economy greased and moving again so that the Nexus of the Forex market can steadily move, that can weaken a currency.

Conversely, if the economy is heating up and signs of improvement are developing then Central Bank may slow down their operations. Also, in the world of trading, a central bank noting that conditions are improving at such a pace that they may begin to adjust their open market operations can swing markets as well. This is what we saw in late October when the Federal Reserve of the US released a statement which omitted a key line about the financial conditions worsening.

Learn Forex: Market Sentiments Can Shift When the Market Misjudges a Central Bank

Presented by FXCM’s Marketscope Charts

Placing a Trade off the Central Bank Decision Print

Later this week, we’ll have both the European Central Bank or ECB and the Bank of England or BoE with their rate decision. By looking at the two questions above, we can see that the latest news releases to have crossed wires affect the ECB’s goals the most. In short, the ECB is focused solely on inflation so the poor CPI reading last week shows that the ECB will likely need to address the threat of deflation which can act as a silver bullet to a recovering economy.

Given the ECB being outspoken about their focus on inflation, the recent CPI data makes Thursday’s ECB meeting one that will have the attention of many traders around the world as EURUSD drops from 2013 highs. As a trader yourself, when the statement is released, it is helpful to look for any guidance or surprise on the next step of action out of the ECB. Simply put, you should look for any indication that the ECB will act on worsening data or pave the road for December rate cuts or Quantitative Easing to weaken the Euro to assist the Eurozone in the face of deflation.

Once you know what to look for, it’s helpful to know what currencies you should look to trade the central bank’s currency against when approaching a central bank meeting. Given the strong or bullish price action of the GBP or USD, they would be a favorable counter currency to sell the Euro against if you get an indication from Thursday’s ECB announcement of further weakness.

Learn Forex: EURUSD Set-up into ECB

Presented by FXCM’s Marketscope Charts

Happy Trading!

---Written by Tyler Yell, Trading Instructor

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