Monetary Policy Divergence

One
thing that can drive the FX market in a more sustained way over the medium/long
term is the monetary policy divergence. This happens when a central bank for
example is pursuing a tighter monetary policy, and another an expansionary
monetary policy. This creates a divergence between the two central banks and
the bigger the divergence, the bigger the movements in the forex market.

Let’s
take a recent example. The Federal Reserve is the US central bank and it’s
currently in a tightening cycle that is expected to become more aggressive with
bigger rate hikes and an earlier balance sheet reduction. On the other hand,
the Bank of Japan is keeping its long lasting loose monetary policy with
interest rates at -0.1%, bond buying programme and yield curve control. These
two are on the very opposite extremes.

USDJPY Daily Chart

As
you can see from the chart above, the corresponding currency pair USD/JPY
rallied strongly for several months, and the speed increased even more in the
last few weeks as the BoJ intervened in the market with more bond purchases to
stem the rising yields since it wants to keep monetary conditions very loose.

When
you trade forex, you should always buy the strong currency and sell the weak
one for the best results. Don’t just look at a price chart and bet your money
on some random lines. First, find the fundamental reasons to buy or sell
something and then use technical analysis to manage your risk and structure
your trade.

This
article was written by Giuseppe Dellamotta