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.
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
