The forex market, with an average daily trading volume of $6.6 trillion, is the largest financial market in the world. It is highly dynamic and subject to a variety of factors, including economic indicators, central bank policies, and geopolitical events.
Geopolitical events can significantly impact forex markets through changes in trade policies. Trade conflicts between nations may lead to the implementation of tariffs, thereby influencing the demand for currencies.
When assessed from a forex trading perspective, geopolitical risks encompass any national and international news that has the potential to affect currency rates. Geopolitical hazards encompass a variety of events that can impact forex markets in different ways.
Acquiring a comprehensive comprehension of the forex market as a whole and the interplay between various markets will facilitate your comprehension of geopolitical news. In this article, we discuss the impact of Geopolitical Events on forex markets.
What Are Geopolitical Events?
Geopolitical events are political and social events that impact global economies, commerce, and financial markets. Among these events are terrorism, elections, conflicts, and natural disasters. They have the potential to cause substantial market sentiment fluctuations, which can lead to price fluctuations in a variety of financial instruments, such as currencies.
Geopolitical risk refers to any potential hazards to a nation's political, economic, military, and social status in relation to other countries. All of these events can significantly affect the forex market, thereby impacting the economic status of multiple countries.
Political unrest, civil conflicts, trade disputes, regime changes, corruption, terrorism, natural disasters, pandemics, and other global health crises are all examples of geopolitical risks. There are numerous ways in which these events affect the value of a country's currency.
They disrupt global trade, which has an impact on countries' GDPs.
Investors' ability to transfer funds from affected currencies to safe-haven assets can influence the entire forex market.
The cessation of access to specific commodities and resources may have an impact on business and national import/export rates.
Geopolitical Events Impact on The Forex Markets
Geopolitical events can have a significant impact on forex markets, both in the short and long term. The repercussions of geopolitical risks on currency volatility frequently extend across multiple currency pairs. Predicting the effects of these events on the forex market is further complicated by the fact that they can affect multiple countries simultaneously.
A trader's reaction to an event that impacts only one currency can have an impact on others. For instance, traders may opt to transfer their assets to safe-haven currencies such as the Swiss franc or Japanese yen in response to increased uncertainty in popular currencies such as the USD and EUR.
In addition to market reactions, central bank responses can have an impact on your trading strategy. The various monetary policies implemented during periods of geopolitical upheaval to stabilize the currency can impact your portfolio in a multitude of ways.
The purpose of higher interest rates is to draw in foreign investment and boost the value of a nation's currency. However, this policy may not have the desired effect if the currency is swiftly depreciating as a result of civil unrest.
In the final analysis, geopolitical events generate volatility in forex markets, which presents traders with opportunities. Although volatility increases the number of trading opportunities, it also increases the inherent trading risks.
Some of the ways in which geopolitical events can impact forex markets are as follows:
Shifts In Trade Policies
Geopolitical events can significantly impact forex markets through changes in trade policies. Trade conflicts between nations may lead to tariffs being implemented, potentially influencing currency demand. Changes in trade policies can also influence a company's supply chain, thereby impacting the value of their respective currencies.
Changes In Political Stability
Political stability significantly influences currency valuations. The value of a country's currency may decrease as a result of political instability or turmoil. Investors tend to steer clear of currencies associated with instability because of the economic risks these countries pose. Elections, coups, and social unrest are examples of geopolitical events that can impact political stability.
Currency Fluctuations
Geopolitical events can also trigger currency fluctuations. For instance, the British pound experienced a significant decline of over 10% in a single day during the 2016 Brexit referendum. Similarly, the Chinese yuan underwent substantial fluctuations because of the United States' imposition of tariffs on Chinese products during the US-China trade war.
Changes In Interest Rates
Geopolitical events can also influence central bank policies, leading to fluctuations in interest rates. Interest rates greatly influence currency valuations, and any fluctuations in these rates can have a significant impact on foreign markets. Investors, for example, may seek higher returns when a central bank raises interest rates, which may result in an increase in demand for the country's currency. In contrast, a central bank's decision to reduce interest rates may result in a decrease in the demand for the currency.
Some Examples of Geopolitical Risks In The Forex Market
Because of geopolitical risks, currency markets are susceptible to significant volatility. Nevertheless, currencies are susceptible to a variety of geopolitical risks, each of which can have a significant impact. We list recent geopolitical events below, along with the trading strategies used to mitigate their market effects.
Russia-Ukraine War
The conflict between Russia and Ukraine had a profound impact on global markets, including European and US equities, currencies, and commodity futures. The onset of the conflict resulted in a surge in energy prices, as certain countries imposed sanctions on Russia and halted oil imports, while others panic-bought an excess of oil in anticipation of increased market volatility. In early March 2022, the price of a barrel of oil reached a 14-year peak of $140.
Wheat futures saw a nearly 60% increase, while corn and soybean futures saw a 15 to 20% increase, with Russia and Ukraine accounting for 30% of the global wheat supply prior to the war.
Most exchanges delisted the Russian central bank's currency, and the forex market blocked its assets. The impeded trade resulted in the depreciation of neighbouring European currencies, such as the Polish zloty.
The equity markets were also subject to volatility as a result of the withdrawal of certain large multinational companies from Russia and the exclusion of Russian companies from a variety of indices. Despite the overall swift recovery of European equity markets from the disruption.
US-China Trade Dispute
In early 2018, the US and China's long-standing tensions culminated in a full-scale trade dispute, which led to escalating tariffs and a hostile trading environment between the two national superpowers. The tariffs affected stock values, commodity prices, and foreign exchange, despite some bystander countries benefiting from filling the gaps left by China and the US's decreasing imports from each other.
The conflict began when the Trump administration in the United States imposed tariffs on Chinese goods, forcing China to pay higher fees for importing and exporting goods to the United States. China's retaliatory tariffs on American products strained the relationship between the two countries.
The tariffs had a volatile impact on the stock prices of the manufacturing, agriculture, and technology sectors. The cost of materials increased, resulting in higher operating costs for companies in both countries. Furthermore, the opposing country's consumer markets contracted.
Tariffs also had a direct impact on commodity prices. Agricultural and energy commodity markets experienced price fluctuations.
As a result of shifting market sentiment, the Chinese yuan and US dollar experienced heightened volatility in response to the change in global trade. Additionally, a variety of other currencies experienced altered correlations. The tariffs actually resulted in a 3% increase in global trade, as other countries, including the European Union, Taiwan, and Vietnam, were able to increase their exports to both the United States and China. As a result, fluctuations in national GDPs had an impact on forex exchange rates.
Strategies For Managing Geopolitical Risks in Forex Trading
For forex traders, geopolitical risks can present substantial obstacles, necessitating the implementation of a risk management strategy. When contemplating the impact of geopolitical events on your trading strategy, it is crucial to be cognisant of the numerous ways in which a conflict or other news event can influence markets.
The first step in trading geopolitical events is to ensure that you are aware of global economic news. Like any event-focused trading strategy, it is essential to concentrate on three critical timeframes that encircle geopolitical events: prior to, during, and subsequent to the event.
Traders may implement the following strategies to mitigate geopolitical risks:
Stay Informed
It is imperative for forex traders to remain informed about geopolitical developments that may affect currency valuations. They can accomplish this by consistently monitoring political events, economic reports, and news outlets. By staying informed, traders can make informed trading decisions and reduce the risks associated with forex trading.
Diversify Your Portfolio
By diversifying their portfolio, forex traders can reduce the risks associated with geopolitical events. This entails diversifying their investments across a variety of financial instruments and currencies, thereby mitigating the effects of any adverse events on a single currency or instrument.
Conduct Technical Analysis
Forex traders can use technical analysis to identify market trends, entry points, and exit points. To inform trading decisions, traders examine historical market data to identify patterns and trends.
Use Stop Loss Orders
Forex traders can employ technical analysis to identify potential trends and entry and exit points in the market. To inform trading decisions, traders examine historical market data to identify patterns and trends.
Conclusion
Currency fluctuations and market sentiment changes may be caused by geopolitical events that have a significant influence on forex markets. In order to mitigate the risks associated with forex trading, forex traders must comprehend the potential influence of geopolitical events on currency valuations and implement suitable risk management strategies.
It is crucial for all traders to remain informed about geopolitical events, regardless of whether they are actively trading or merely seeking to safeguard their portfolios from the risks they entail.
It is generally advisable to maintain a long-term perspective in the face of short-term volatility. Trading geopolitical events can be compared to breakout trading, in that the objective is to initiate trades prior to the breakout, incorporate safety netting such as stop-loss orders, and refrain from entering transactions after the initial burst of momentum has occurred.
To withstand geopolitical events, it is critical to maintain balanced asset allocation and diversify your portfolio in accordance with your risk tolerance. Safe-haven currencies and other instruments, such as precious metals, are excellent methods for hedging your riskier transactions.
