Fundamental Analysis: Interpreting Central Bank Conferences

Fundamental analysis is a practice of vital importance for those who engage in Forex Trading (like any other type of trading). It allows, in fact, to intuit price movements based on the impact they undergo due to major economic and political events. These events, especially if they occur at a scheduled and regular frequency, are called market movers. Obviously, there are important market movers and less important market movers. Some have an impact on all currency pairs (certainly to varying degrees), while others are specific to a particular pair. The most important market movers, which no trader can afford to neglect, concern central banks. Some of these, although officially impacting only one currency, exert a great influence on Forex in general. The reference is to the most important central banks of all, namely the American Federal Reserve (Fed) and the European Central Bank (ECB). In the following article, we will provide an overview of the role that central banks, especially the most famous ones, play in fundamental analysis. Subsequently, we will focus on a particular market mover, which is wrongly considered an appendix: the post-meeting conference of central banks.

Central banks and fundamental analysis

Central banks are considered a bit of a reference point for all traders, especially during fundamental analysis. In fact, they are responsible for powerful market movers, capable of really moving the market and influencing prices. It's a dynamic to be strongly taken into consideration. The risk, if one does otherwise, is to see the evidence collected during technical analysis (which only considers charts and neglects the economic and political environment) refuted one by one. A risk that, in hindsight, can lead to disastrous consequences and the loss of substantial sums. What are the market movers that central banks issue? There are two "institutional" ones and two that respond more to a need for practice. Interest rates. One of the tasks of central banks, regardless of their statute (which may vary in forms and general objectives), is to modify the cost of money when necessary, so as to enable the economic system to cope with risks and express its potential. By interest rate, in this case, we mean the rate at which commercial banks receive money from the central bank itself, which is the primary source of money for the real economy. It's what is commonly called the "cost of money". Quantitative Easing. Central banks, precisely to intervene in periods of economic recession and the consequent risk of low liquidity, may decide to put in place a particular and powerful initiative: quantitative easing. It consists of the central bank purchasing public and private debt securities at zero interest. Central bank Quantitative Easing, in short, directly "finances" the real economy. Monetary policy outlook. This is a "practical" market mover. Central banks often communicate in advance how they will move in the coming months, if not even years. The reason is to prevent the market from reacting excessively to monetary policy initiatives. In short, they anticipate future interest rates and developments in Quantitative Easing. These statements are made during public meetings and, above all, during post-meeting press conferences. Real economy outlook. Central banks have a main purpose: to keep inflation at optimal levels. Others, such as the Fed, also have "collateral purposes", namely to foster economic development, in a perspective of moderate interventionism. For this reason, they often tend to provide, by practice or according to regular deadlines, forecasts, outlooks, and general opinions on the future of the real economy. This function is so useful that, at times, it is even exercised by those central banks (e.g. the ECB) that in theory do not deal or deal very little with the real economy.

Central bank market movers and fundamental analysis

How do these market movers interact with the price? To tell the truth, in a fairly clear way, at least compared to many other market movers. Generally speaking, expansionary monetary policy initiatives tend to produce a certain depreciation trend on the currency. Expansionary monetary policy means lowering interest rates, establishing a quantitative easing program or expanding it (in terms of time, extending its duration, or in quantitative terms, increasing the funds for purchases). The dynamics behind this phenomenon are both technical and psychological. From a technical point of view, by virtue of the law on the velocity of money, the greater the money supply within a system, the lower its value will be. Now, it is obvious that a decrease in interest rates produces an increase in the money supply, and the consequent (trend) devaluation. From a psychological point of view, the game is played on expectations: faced with a lowering of interest rates, traders expect a depreciation. Consequently, they sell to protect capital, making this depreciation even more significant. The same goes for Quantitative Easing, which is a method - if possible even more direct than interest rates - to increase the money supply in circulation.

How to interpret central bank conferences

Post-meeting conferences of central banks represent the moment (or place) in which the boards, often through the voice of the president, express forecasts and opinions. Forecasts about future monetary policy (more than anything else, statements of intent) and about the performance of the economy, opinions about the economy itself and, certainly in a veiled way, on the political context. How to read central bank conferences? Here are some tips. Analyze previous conferences. The words in a conference only make sense if compared with the statements of previous conferences. The reason is simple: central banks do not speak randomly, but apply the principle of forward guidance, that is, guiding the market through statements. In this perspective, the individual statement is inserted in a larger context, in a kind of plan, which has a very specific purpose. Considering previous conferences means understanding the contours of this plan and grasping the true meaning of a central banker's words. Be aware of the president's personality. Every banker, as is right, has their own personality. Some are more talkative, others more cryptic. Knowing the individual's approach allows giving the statement the right weight. For example, Mario Draghi is usually moderate, he doesn't take sides, so an explicit statement from him hides a much greater force than a statement of the same tenor but pronounced by a colleague. Know how investors move. Based on expected reactions, and the way in which they behave when important news "bursts in", it is possible to frame press conferences more precisely. If, for example, euro investors are known for their emotionality, an apparently neutral statement by the banker actually takes on a much stronger meaning.