Currencies: All About Central Banks?

When you trade currencies, it is all about Central Banks. If you don’t keep an  eye on the monetary policy being followed by the Central Bank, you will have no clue where that currency is going. Talk about EURO! Last week Mario Draghi, President of ECB set the deposit rate negative and EUR/USD showed a wild reaction. First it went down, found support at 1.35031 then shot up and found resistance at 1.36699 in around 8 hours. Read this post on rigging and market manipulation and what UK Chancellor of Exchequer wants to do about it.

Central Banks are the most important players in the market. They have the power and the tools to make the markets do what they want. The most important tools at their disposal is the power to set the interest rates in the economy plus the power to increase or decrease the money supply. In US, Federal Reserve Open Market Committee (FOMC) Meeting is held every month in the beginning that reviews the economy and decides whether to increase the interest rates or not. FOMC Meeting can decide to increase the money supply in US economy by selling or buying or US Treasuries.

When the FOMC decides to buy US treasuries from the market this increases the money supply in the economy and when it decides to sell US treasuries, it decreases the money supply. Buying and selling of US Treasuries is known as Open Market Operations. These open market operations are sterilized. If you take an intermediate level course in Macroeconomics, you will understand how these operations are sterilized. The idea is to make these operations so that they don’t increase the inflation. When inflation comes gold become expensive. Read this post why NFP Report will test Gold resilience this time.

When the financial crisis started after the 2008 stock market crash, Federal Reserve made the interest rate almost zero and started its program of Quantitative Easing also known as QE. QE was meant to inject a lot of money in the economy to reduce the problem of liquidity. QE entailed buying trillions of dollars of US Treasuries. QE continued for many years. After many years, there are clear signs of US economy once again picking up heat so the Federal Reserve has increased the interest rates. This is done to combat inflation.

European Central Bank (ECB) also is a very important central. Its task is also very challenging as it has to navigate through the national interests of many countries that form part of European Union. ECB also started its QE program when European economy nose dived into a tailspin. Sovereign debt problem was a major issue. Many countries had taken heavy debt and were facing problems in repayment. The chief amongst them was Greece.

Another very important central bank is Bank of Japan. Bank of England is also another important central bank. If you are a currency trader, you should better take a course on how these Central Banks operated. This course can help you do fundamental analysis in a much better manner. Did you read the post on NFP Report and why it is important?