How Forex Markets Are Affected by Geopolitical Tensions

When assessing geopolitical risks from the standpoint of forex trading, any domestic and international news that has the potential to affect currency rates is considered. Geopolitical risks can be many different things, and they can affect FX markets in different ways.

Acquiring a comprehensive comprehension of the broader foreign exchange market and the interplay between various markets will facilitate your ability to navigate geopolitical news. This tutorial provides instances of different geopolitical concerns and how they could affect the foreign exchange market, along with concrete examples and prospective trading tactics.  

What trading risks are related to geopolitics?

Any threat to a nation’s political, economic, military, and social standing with other nations is referred to as geopolitical risk. Each of these occurrences has the potential to have a significant effect on the financial situation of several nations, which would rock the FX market.

Political instability, civil wars, trade disputes, regime transitions, corruption, terrorism, natural catastrophes, pandemics, and other global health emergencies are a few instances of geopolitical dangers. These occurrences have various effects on a nation’s currency value.

  • Global trade disruptions have an impact on the GDPs of participating nations.
  • The entire foreign exchange market may be impacted if investors shift their money from volatile currencies into safe-haven investments.
  • There may be restrictions on access to certain resources and commodities, which would affect company and national import/export rates.

How developments in geopolitics affect FX markets

Geopolitical uncertainties have an effect on currency volatility that frequently ripples through several currency pairs. Predicting these events’ effects on the currency market gets much more complicated because they can have simultaneous effects on several countries.

The way traders respond to an incident that affects one currency might affect others as well. For instance, increased trepidation among traders in well-known currencies like the USD and EUR may persuade dealers to shift their holdings to safe-haven currencies like the Swiss franc or the Japanese yen.

Your trading strategy may be impacted by central banks’ responses in addition to market movements. Your portfolio may be impacted by a variety of monetary policies that are enacted during periods of geopolitical unrest with the goal of stabilizing the currency.

Higher interest rates draw in foreign capital and are designed to make a nation’s currency more valuable, but if the currency is rapidly losing value because of political instability, this policy may not work as planned.

In the end, movements in the currency markets, or volatility, are a result of geopolitical events and present trading possibilities. Increased volatility raises the risks associated with trading even as it increases trading opportunities.

Continue reading to get more about particular trading tactics for erratic markets like forex, or jump straight into real-world instances of geopolitical events and their effects on the economy.

How choices made by central banks affect foreign exchange

Monetary policy is carried out by central banks in reaction to the economic ramifications of geopolitical developments. One instance is during the Covid epidemic, when the US Federal Reserve lowered the federal funds rate to 8% in order to make borrowing less expensive for individuals and companies.

By adjusting interest rates, buying and selling their own currency, issuing forward guidance, and implementing quantitative easing, central banks aim to impact monetary policy. Comprehending the mechanisms employed by central banks to regulate money in reaction to geopolitical upheavals is equally crucial to your trading approach as the events themselves.

Geopolitical risk examples in forex

Currency markets are susceptible to extreme volatility due to geopolitical issues. Geopolitical risk, however, comes in a variety of forms, and each can have a unique impact on currencies. The geopolitical events of recent times and the trading tactics employed to manage their effects on the market are delineated here.

COVID-19 epidemic

A prime illustration of a worldwide health disaster in the context of our contemporary economic system is the Covid epidemic. Significant fluctuation in major currency pairs and market volatility across all asset classes were caused by the outbreak.

As a safe-haven currency, the US dollar, for instance, gained value in comparison to other currencies such as the British pound sterling (GBP), New Zealand dollar (NZD), Canadian dollar (CAD), Mexican peso (MXN), and South Korean won (SKX), which are more reliant on international trade and commodities. In contrast to the euro (EUR) and Swiss franc (CHF), two other safe-haven currencies, the dollar lost at least 5% of its value in the first half of 2020.

Governments and central banks also implemented radical measures in an effort to stabilize currencies. Zero interest rates were implemented, along with severe demand swings and supply chain infrastructure problems. International trade was also affected.

War between Russia and Ukraine

The conflict between Russia and Ukraine had a significant impact on international markets, affecting US and European equities, commodities futures, and currencies. As a result, rising energy prices exacerbated the already high rates of inflation brought on by the stimulus measures central banks were implementing as part of their Covid recovery programs.

When the war first started, energy prices spiked because some nations placed sanctions on Russia and stopped importing oil, while others panicked and bought more oil than they needed in anticipation of further market volatility. Early in March 2022, the price of an oil barrel hit a 14-year high of $140.

Before the conflict, 30% of the world’s wheat supply came from Russia and Ukraine, which led to a nearly 60% increase in wheat futures and a 15%–20% increase in maize and soybean futures.

The Russian Central Bank’s currency was delisted from the majority of exchanges and its assets were blocked in the foreign exchange market. As trade was hindered, the value of neighboring European currencies, such as the Polish zloty, also decreased.

The withdrawal of certain major international corporations from Russia and the exclusion of Russian companies from different indices caused turbulence in the equity markets as well. Despite this, the European equity markets rebounded from the disruption quite swiftly overall. 

Trade conflict between the US and China

Early in 2018, long-simmering tensions between the US and China became more intense, leading to higher tariffs and a hostile commercial environment between the two national heavyweights. The tariffs affected foreign exchange, stock values, and commodity prices; nevertheless, other spectator nations profited from the gaps created by China and the US cutting back on imports from one another.

The Trump administration’s tariffs on Chinese imports, which required China to pay higher import and export duties to the US, marked the beginning of the dispute. China’s tariffs on American goods in retaliation caused the two nations’ relationship to deteriorate.

Stock prices fluctuated in the manufacturing, agricultural, and technological sectors that were impacted by the levies. Operating costs increased for businesses in both nations as the cost of materials increased and the consumer markets in the other nation contracted.

Tariffs also had a direct impact on commodity prices. There were price swings in the commodities markets for oil and agriculture.

Due to shifting market sentiment, the US dollar and the Chinese yuan both saw heightened volatility. Additionally, correlations among different currencies changed in response to the shift in global commerce. Due to the possibility for other nations like Taiwan, Vietnam, and the European Union to increase exports to both the US and China, the tariffs actually resulted in a 3% rise in world commerce overall. Foreign exchange pair rates were then affected by changes in country GDPs.

Trading tactics in the face of geopolitical threats

You should be completely informed of the various ways a conflict or other news event might shift markets when thinking about how geopolitical events will affect your trading approach.

Being informed about world economic news is the first step in trading geopolitical events. Every significant economic statement is highlighted in our economic calendar, and our in-depth analysts’ coverage of the FX market offers an excellent opportunity to gain insight into how experts evaluate both anticipated and unforeseen geopolitical developments.

You should concentrate on three critical time frames surrounding geopolitical events: before, during, and after, just like with any event-focused trading method.

Preparation plan for international affairs

You should position your portfolio for volatility in the run-up to an anticipated event, such as a trade conflict or a change in government policy. Most traders make sure they have a suitable hedge in place and that their assets are diversified before any major events occur. Certain geopolitical occurrences, like pandemics and wars, might surprise you. By consistently controlling portfolio risk, you may prevent any surprises from crushing you.

During the geopolitical incident, trading

Market volatility increases as the geopolitical event develops, and you find out if your assumptions are realized or not. The event’s duration may determine how long the market is impacted—up to a year or longer. But eventually, the turbulence brought on by a geopolitical event will abate. Despite the ongoing conflict between Russia and Ukraine, oil prices experienced an almost 50% increase in the first two months of 2022 before stabilizing around January 1st levels by the end of the summer.

Trading after geopolitical events

Following a geopolitical event, markets typically go through a period of consolidation or corrections. Now is a good time to review your portfolio to make sure that asset allocation and risk management practices reflect the current state of the economy.

Conclusion

Whether you actively trade geopolitical events or want to shield your portfolio from the risk they entail, it is imperative for all traders to remain informed about these developments.

Keeping a long-term perspective in spite of short-term volatility is a typical rule of thumb. One way to compare trading geopolitical events to breakout trading is to open positions before the breakout happens, incorporate safety nets such as stop-loss orders, and refrain from initiating positions after the initial surge of momentum has passed.  

You must constantly adjust your asset allocation and diversify your portfolio in accordance with your risk tolerance in order to weather geopolitical developments. Precious metals and other safe-haven currencies are excellent tools for hedging your riskier transactions.

FAQ’s

How do geopolitical risks happen?

Natural disasters, trade disputes, and wars are examples of threats to a country’s political, economic, military, and social status that might affect the value of its currency.

What impact do developments in geopolitics have on currency markets?

They affect GDPs and import/export rates, induce volatility, cause trade disruptions, and encourage investors to switch to safe-haven currencies.

What is a money that is a safe haven?

A reliable currency that investors seek out in times of geopolitical unpredictability, such as the Swiss franc (CHF) or Japanese yen (JPY).

What is the response of central banks to events in geopolitics?

To stabilize the economy, they change interest rates, purchase and sell currencies, and carry out programs like quantitative easing.

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