Hawkish vs. Dovish – Central Bank Squawk

In the news, I often heard about central bank meetings centered on “hawkish” or “dovish” monetary policies – I didn’t know what they meant and decided to find out.

It turns out, that similar to bull (up) and bear (down) markets, these animal references provide you a direction on the general sentiment of the central bank / its monetary policy.

“The Fed is hawkish.” – Let’s break this down.

First, the “Fed” is the Federal Reserve System for the United States – our equivalent of the Bank of Canada (“BofC”) – and controls the monetary policy.

Hawkish

Second, “hawkish” refers to the stance of a central bank guarding against excessive inflation by raising interest rates.

Inflation refers the increase in overall price of foods and services; deflation is the respective decrease. As economies grow, wages increase and/or the cost of raw products. However, this can be bad as if everything appreciates too quickly, as people will be unwilling or unable to buy things.This is often not sustainable. So, banks try to keep the economy growing at a more reasonable pace by watching the inflation, usually by raising interest rates – a “hawkish” stance. This is what has been happening with the U.S. and Canada.

As interest rates increase:

  • International investors move their money to a country where they can get higher interest rates à currency rises/strengthens

  • Economy growth slows

    • As money becomes more expensive to borrow, businesses borrow less money to expand and people spend less through borrowed money

  • Inflation is controlled

To remember “hawkish” as rising interest rates:

Hawks fly high in the sky – high interest rates with hawks guarding the upper limit of inflation.

Dovish

In a dovish policy of lowering or keeping low interest rates, the central bank is helping a slow economy, guarding against deflation. This stimulates the economy – “cheap” money encourages businesses to start borrowing and expanding, people to spend more money as cost of goods decrease.

As interest rates fall / remain low:

  • Investors move out their money from the country, in hopes of finding higher interest rates

    • Note that although a lower interest rate will usually weaken a currency, the relative interest rate vs. other countries is important

  • Economy growth rises

    • “Cheap” money incites consumer spending and business borrow at cheaper rates to grow, government builds more roads, infrastructure, etc. as municipal bond yields drop

  • Inflation is promoted

To remember “dovish” as low interest rates:

Doves, placid and gentle in nature, are protectors of consumers – guarding against deflation to increase spending by lowering interest rates.

Congratulations! Now you have a better understanding of the two terms. Hawkish implies higher interest rates, and dovish implies lower interest rates.Central banks will not outrightly state that they are hawkish or dovish, however – this is interpreted by the public.

To leave you with a few key central bank facts:

  • Jerome Powell is the Chairman of the Fed

  • Stephen S. Poloz is the Chairman for the Bank of Canada

  • Mario Draghi is the Chairman for the European Central Bank

  • The next U.S. Fed meeting is on 19-Dec-18, followed by 30-Jan-19

    • Fed is expected to continue hiking rates

  • The next Canadian BofC meeting is on 5-Dec-18, followed by 9-Jan-19

    • BofC is expected to continue hiking rates

Katya

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