Numerous factors impact and influence forex trading. Many have to do with macro and microeconomic factors, but politics also plays a significant role, too.
It can shape investor mood and sentiment, affect volatility, and even set trends that impact how traders approach specific currency pairs. The relationship between currency strength and politics is strong and complex, and this is what we will be exploring in this article.
Monetary Policies and Central Bank Policies
While many economists agree that this should not be the case, most central banks’ policies are heavily influenced by political actions. For example, politicians might pass laws that dictate money supply and interest rates. Both of these directly influence inflation rates that impact the strength of specific currencies.
Interest rate adjustments and quantitative easing initiatives are areas of particular concern because they can swing currency values due to their influence on the market and currency perception.
Economic Policies
Politicians can also set and implement various economic policies that impact the forex market. New taxation measures, trade agreements, and stimulus packages can all exert a lot of influence on trade balance, economic well-being, and inflation rates.
The uncertainty they present when they are announced and as they are implemented can lead to volatility in the forex market as investors try to understand the potential ramifications and weigh different options and outcomes. Once they do, they are likely to adjust their trading positions, resulting in some currency pairs seeing additional activity and others flattering.
Investors must always keep an eye on the economic policies of countries whose currency pairs they are interested in. Doing so will inform their online forex trading strategies and ensure they can take advantage of these policies’ outcomes. They might also exit their positions because they feel these policies introduce too much volatility that increases their risk.
Geopolitical Tensions
Very few countries do not have hostile relationships with at least one other country. Additionally, new geopolitical tensions can arise overnight, impacting the forex market in several significant ways.
The most consequential effect is investors and traders switching to more stable and safe currencies. They typically include the Japanese Yen, Swiss Franc, and US dollars, which have remained stable for much of modern history.
As more investors switch to them to use them as shelters, their values appreciate due to the increasing demand and supply that cannot keep up. Any currency pairs trading against them are impacted, with their relative value diminishing as a result.
Election Cycles
Election cycles impact the forex market in ways many people do not realize. One significant way is a reduction in direct foreign investment. When political tensions rise around election time, investors avoid those markets because of the uncertainty and high risk they present. The result is lower foreign currency reserves, which diminishes the value of the country hosting the election and faces lower-than-normal investment levels.
Elections also mean leadership changes. We have seen that leaders can make decisions or introduce policies that impact the forex markets. Investors wait to see who gets elected so they can have a better idea of the policies they are likely to introduce. If they think these policies will be unfavorable, they avoid investing, which leads to the situation discussed above.
Trade Sanctions and Global Supply Impacts
Almost every country in the world exports products or services to other countries. However, some countries are more dependent on exports than others, and this is often the case in those with huge commodity reserves.
Sanctions that make it difficult to export commodities like precious metals, oil, and agricultural produce can significantly impact the valuation of the affected country’s currency. The result is other currencies strengthening against it and providing additional opportunities for interested investors.
The reverse can also happen. A country’s currency can strengthen once sanctions are lifted it starts exporting again.
Debt Levels and Credit Ratings
If a person cannot service a loan, lenders typically regard them as low-value and high-risk borrowers. The same happens to the country. Countries that cannot pay off their debts can be categorized as high-risk by other countries. Investors can then start viewing its currency as high risk and avoid it. This can lead to the currency getting highly devalued or high volatility in the given market.
Advancements and Developments Occasioned by Politics
Politicians can implement policies like increasing manufacturing output, mending diplomatic relationships, or making policy reforms that improve market perception and sentiment. This has the potential to affect a currency positively.
The opposite can also happen if a government implements adversarial policies. The result is often sell-off and currency devaluations.
Politics greatly influence the forex market, with policy changes, new regulations, and different choices all becoming catalysts for changes in currency values and sentiment surrounding them. Traders and investors must keep an eye on the political happenings of the countries whose markets and currencies they are interested in to identify potential opportunities or avoid risks that could severely impact their investments.
