How geopolitical risk impacts forex trading

Geopolitical risks, when evaluated from a forex trading perspective, include any national and international news with the power to influence currency rates. Many different events qualify as geopolitical risks, and they have the potential to influence FX markets differently.

Gaining a thorough understanding of the wider forex market and how different markets interact with one another will help you better navigate geopolitical news. This guide serves as an example of various types of geopolitical risks and the potential they have to influence forex, including specific examples and possible trading strategies.  

What are geopolitical risks in trading?

Geopolitical risk describes any threats to the status of a country’s political, economic, military and social standing with other countries. All of these events can drastically impact the economic standing of multiple countries, sending shockwaves across the forex market.  

Examples of geopolitical risks include political unrest, civil wars, trade disputes, regime changes, corruption, terrorism, natural disasters, pandemics and other global health crises. These events impact a country’s currency value in several ways.

• They upset global trade, which affects involved nations’ GDPs
• Investors can move funds out of affected currencies and into safe-haven assets, impacting the entire forex market
•  Access to specific commodities and resources may be cut off, impacting business and national import/export rates

How geopolitical events impact forex markets

The impact of geopolitical risks on currency volatility often reverberates across multiple currency pairs. Because these events can affect multiple countries at once, predicting their impacts on the forex market becomes even more convoluted.

Even an event affecting just one currency can impact others by how traders react. For example, heightened uncertainty from traders in popular currencies like USD and EUR can influence traders to instead move their holdings to safe-haven currencies like the Japanese yen or Swiss franc.

Beyond market reactions, how central banks respond can also influence your trading strategy. Various monetary policies implemented at times of geopolitical upheaval aiming to stabilize the currency can affect your portfolio is many ways.

Higher interest rates attract foreign investment and are meant to increase the value of a country’s currency, but that policy may not have its intended effect if the currency is rapidly depreciating due to civil unrest.

Ultimately, geopolitical events create movement—or volatility—in forex markets that provide opportunities for traders. While increased volatility provides increased trading opportunities, it also heightens risks inherent in trading.

Learn more about specific trading strategies for volatile markets like forex, or keep reading as we dive deep into examples of geopolitical events and their economic impacts.

How central bank decisions influence forex

Central banks implement monetary policy in response to the economic effects of geopolitical events. One example is when the US Federal Reserve set the federal funds rate to O% to lower the cost of borrowing for households and businesses during the Covid pandemic.

Central banks work to influence monetary policy through interest rates, buying and selling their own currency, providing forward guidance and quantitative easing. Understanding how central banks work to control money in response to geopolitical shakeups is just as important to your trading strategy as the events themselves.

Jump into our free academy program for a complete breakdown of all of the major central banks.

Examples of geopolitical risks in forex

Geopolitical risks have the ability to create massive volatility throughout currency markets. However, there are many types of geopolitical risk and each kind can affect currencies in numerous ways. Below we outline some recent geopolitical events and trading strategies used to navigate their impacts on the market.

Covid pandemic

The Covid pandemic is a prime example of a global health crisis within our modern economic system. The pandemic precipitated significant market volatility across all asset classes and created significant movement in major currency pairs.

For example, the US dollar, functioning as a safe-haven currency, appreciated relative to currencies more dependent on commodities trade and international business like the British pound sterling (GBP), New Zealand dollar (NZD), the Canadian dollar (CAD), Mexican peso (MXN) and South Korean won (SKX). Compared to other safe haven currencies—the euro (EUR) and Swiss franc (CHF)—the dollar depreciated by at least 5% in the first half of 2020.

Central banks and governments also took drastic steps in an attempt to stabilize currencies. Interest rates were set to zero, international trade was also distributed with extreme fluctuations in demand and critical issues arising within the supply chain infrastructure.

Russia-Ukraine war

The war between Russia and Ukraine severely affected global markets including commodity futures, forex, and European & US equities. Rising energy costs as a result worsened already high inflation rates caused by stimulative fiscal policy central banks were enacting as part of their Covid recovery plans.

A spike in energy prices occurred at the onset of the war, as some countries imposed sanctions on Russia and halted oil imports while others panic-bought an excess of oil anticipating more market volatility. Prices for a barrel of oil reached $140 in early March 2022, a 14-year high.

Learn more about trading correlations between oil and forex.

Russia and Ukraine produced 30% of the global wheat supply prior to the war, causing wheat futures to rise nearly 60% and future for corn and soybeans to rise 15 to 20%.

In the forex market, the Russian central bank had its assets frozen and its currency unlisted from most exchanges. Neighbouring European currencies like the Polish zloty also depreciated as trade became impeded.

Equity markets also experienced volatility as some large multinational companies withdrew from Russia and Russian companies were excluded from various indices. Although European equity markets as a whole recovered rather quickly from the disturbance.  

US-China trade dispute

Long-simmering tensions between the US and China erupted into a full-blown trade dispute in early 2018, resulting in increasing tariffs and a negative trading atmosphere between the two national superpowers. Stock values, commodity prices and foreign exchange were all impacted by the tariffs, although some bystander countries benefited by filling holes left by China and the US decreasing imports from one another.

The conflict began when the Trump administration in the US imposed tariffs on Chinese goods, forcing China to pay higher fees when importing and exporting goods to the US. China retaliated with its own tariffs on American goods, and the relationship between the two countries soured.

Manufacturing, agriculture and technology sectors affected by the tariffs experienced stock price volatility. Companies in both countries saw an increase in operating costs as materials became more expensive and consumer markets in the opposing country shrunk.

Commodity prices were also directly affected by tariffs. Price fluctuations occurred in markets for agricultural and energy commodities.

Both the Chinese yuan and US dollar saw increased volatility due to changing market sentiment; and correlations among various other currencies shifted in reaction to the change in global trade. The tariffs actually increased overall global trade by 3 percent as other countries like Taiwan, Viet Nam and the European Union had the opportunity to increase exports to both the US and China. The changes to national GDPs then influenced forex pair rates.

Trading strategies during geopolitical risks

When considering the effects of geopolitical events on your trading strategy, you should be fully aware of the many ways a conflict or other news event can move markets.

The first step to trading geopolitical events is ensuring you are up-to-date on global economic news. Our economic calendar highlights every major economic announcement, and our robust analysts' coverage of the forex market is a great way to learn how professionals interpret both expected and unexpected geopolitical events.

Like any event-focused trading strategy, you should focus on three crucial timeframes surrounding geopolitical events: before, during and after.

Lead-up strategy for geopolitical events

In the lead-up to an expected event like a trade dispute or regime change, you should prepare your portfolio for volatility. Most traders ensure their assets are diversified and they have a proper hedge going into any significant event. Some geopolitical events such as wars and pandemics may come as a surprise. Regularly managing portfolio risk will help you avoid getting wrecked by any surprises.

Trading during the geopolitical event

As the geopolitical event unfolds, market volatility spikes and you learn whether your expectations come true or not. Depending on what sort of event is occurring, the market could be affected for a year or more. Eventually, though, the volatility caused by a geopolitical event will smooth out. Oil prices, which rose almost 50% in the first two months of 2022, returned to January 1^st prices by the end of the summer despite the Russia-Ukraine war still carrying on.

Post-geopolitical event trading

After the geopolitical event, markets usually experience a period of corrections or consolidations. It’s a good time to reassess your portfolio to ensure risk management and asset allocation levels align with the new economic landscape.

Conclusion

Geopolitical events are important for every trader to stay aware of, whether you actively trade geopolitical events or want to protect your portfolio from the risk they incur.

A general rule of thumb is to maintain a long-term perspective despite short-term volatility. Trading geopolitical events can be likened to breakout trading—you want to open trades before the breakout occurs, include safety nets like stop-loss orders, and avoid entering trades after the initial burst of momentum has occurred.  

To weather geopolitical events, it’s vital you regularly balance your asset allocation and diversify your portfolio according to your risk level. Safe-haven currencies and other instruments like precious metals are a great way to hedge your riskier trades.

Learn more about risk management or read our analyst coverage of global markets. When you’re ready, you can practice trading risk-free with a City Index demo account.