How Do Geopolitical Factors Impact the Forex Markets?

By Elad Mor

Meta: Increase your trading success by learning how geographical factors, politics and international relations affect trading in Forex.

The Forex market is the most active financial market on the planet, and also has the highest liquidity. Every day, traders from all the corners of the globe take part in foreign exchange transactions worth more than $4 trillion. Because this market touches every country's economy and is a highly inter-connected marketplace, it is extremely sensitive to geopolitical events that can cause an immediate effect on the prevailing currency rates. In this article, we look at some of these events, and the effect they have on the money markets.

Political Events or Unstable Government

Elections often have a huge and instant impact on the value of a country's currency. When elections are considered by Forex traders to be a potential cause for social and political instability, the country's currency becomes highly volatile because they are unsure of what to expect.

When a country has a change of government, it often comes along with a corresponding change in ideology. This could mean a new approach to monetary policy and fiscal regimes, both of which are important in determining the value of the country's currency.
In addition, the election to office of individuals or political parties considered more fiscally responsible or who show concern for the promotion of economic growth, will boost the value of the currency.

When an election is unexpected, it can have a significant and instant impact on the relative value of a currency. Whether the election is due to scandal, an abuse of office, a non-confidence vote or other unforeseen situations, an unplanned election can adversely affect the value of a currency. This is especially true if the elections are preceded or accompanied by protests or work stoppages. Even if an autocratic government is being replaced by one that is more democratic, the uncertainty that such protests cause, result in traders steering clear of the currency, resulting in a drop in its value.

Natural Disasters

The aftermath of a major natural disaster is total catastrophe for a country. Natural disasters such as hurricanes, earthquakes, tornados and floods not only destroy vital infrastructure, but also physically and psychologically harm the citizens. Additionally, these disasters also have a profound negative effect on the currency of the country. The loss of life, destruction of major industrial and distribution infrastructure and the uncertainty that comes with an event beyond human control are bad news for any currency.

Damage to infrastructure is a major concern because of the fact that for any economy to be successful, it is essential that basic infrastructure be in place and operational. Any breaks in the integrity of a country's infrastructure will place severe limits on the region's economic output. Furthermore, cleaning up and rebuilding infrastructure in the aftermath of a disaster is an additional and unexpected cost that eats into government and private spending which should have been used for ventures that would have strengthened the economy, rather than patch up breaks in the value chain.

Major natural disasters almost always result in a decrease in consumer spending because of economic uncertainty due to possible loss of livelihoods as many businesses will have been damaged or destroyed, in addition to significant loss of consumer confidence. A country's economic strengths can be transformed into weaknesses in the blink of an eye, especially when the country's economy is compared to those of countries with which it competes with in the export market. This is because these countries provide the services that the stricken country can no longer provide, weakening its currency against theirs. All said, a natural disaster almost surely means that a country's currency will be hit hard.

Wars and Civil Disturbances

When talking about war, we do not mean a currency war – where countries try to actively devalue their currency in order to give their economy an advantage when exporting globally. What we mean is the impact that a physical war has on the Forex market, and it is not pretty. In much the same way as a natural disaster does, a war has a brutal and widespread impact.

As was discussed with regard to natural disasters, the damage that war deals to physical infrastructure always deals a blow to the country's short-term economic progress, costing the nation billions, of which a big chunk must be borrowed. The rebuilding efforts necessary after a war are often financed by sourcing cheap capital after lowering of interest rates. This inevitably devalues the local currency. Currencies of countries at war are also much more volatile than those of countries not actively involved in confrontations.

Final Word

The above are just some of the geopolitical events that significantly affect the currency markets, and which Forex traders are constantly following in the news. The key take away from this article is that the value of a currency depends on the nation's economic strength and stability. For this reason, any catastrophic event or future uncertainty about the ability to predict the country's economic outputs will always work against the relative strength of the country's currency. With this in mind, when you trade Forex or binary options forex with leading brokers, such as Option.FM, it is vital to have a clear understanding of the geopolitical events happening in the world and the impact these events will have on the currency you wish to trade.