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The Central Bank Trade Evolved, Strongest with Dollar and Risk Aversion

The Central Bank Trade Evolved, Strongest with Dollar and Risk Aversion

John Kicklighter,

Talking Points:

• Analysis of and adaptation to central bank efforts has been a key dynamic of successful trading for for years

• The 'Central Bank Trade' refers to a number of methods to take advantage of these groups' heavy-handed influence

• Extremes in policy, speculative reach and a confluence of bearings has changed the influence of this driver

See how retail traders are positioning in the majors using the SSI readings on DailyFX's sentiment page.

The 'Central Bank Trade' can refer to different aspects of current monetary policy's influence on the markets and the opportunity of trading the influence/distortion. That said, there is one consistency across these different definitions: they have changed substantially over the past few years. If you continue to approach the markets with the same assumptions shaped around this fundamental theme that were employed back in 2009 to mid-2015, it is likely to end in confusion and frustration.

Among the most common interpretations of the Central Bank Trade for FX traders looks to pit hawkish versus dovish counterparts. This has presented some remarkably large opportunities over the past years. EUR/USD dropped from 1.1400 to 1.0500 in approximately 10 months largely owing the severe disparity in policy bearings between the Fed and European Central Bank (ECB). A similar scenario arose for the Japanese Yen. The currency dropped across all its major counterparts over the course of years as the Bank of Japan (BoJ) made a concerted effort to devalue its currency via stimulus efforts. Yet, in the past year, we have seen pushes to even more greater extremes on the dovish side generate gains not losses for the Euro and Yen. This reflects a distinct drop in the 'effectiveness' of monetary policy and a skew to a standard trade interpretation.

Another common method to assess and invest on monetary policy is analyzing its influence in the aggregate. The rise of stimulus and central bank balance sheets the world over charged a global reach for yield that motivated a benchmark like the S&P 500 to one of its most consistent advances (between 2011 and 2015) seen in modern history. Front running the collective swell in financial assets drew the same kind of mentality for investment seen in previous bubbles - like the Dot-com bubble between 1997 and 2000. Yet, the same transition to desperation and complacency is showing throw in this current phase. We discuss the evolution and pitfalls of this important market dynamic in today's Strategy Video.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.