Positioning according to major macroeconomic events
This lesson will cover the following
- General thoughts on major macroeconomic events
- Most influential macroeconomic events
In the previous article we discussed central bank interventions and emphasised their significance for both short-term and long-term traders. While some market participants focus only on scheduled economic data releases, monetary policy decisions or verbal interventions, they often ignore major macroeconomic events that can influence not just a single currency’s valuation but reverberate across the entire forex market.
Among the most influential macroeconomic events which have the potential to reshape the markets are:
– Wars resulting from increasing geopolitical tensions
– G7 meetings
– Major central bank meetings and other important summits
– Presidential or parliamentary elections in G7 countries
– Debt defaults by large countries
Knowledge makes the difference
It is crucial for day traders to be informed and to know when one of those events might occur, so they have time to assess their positioning properly. Although you can’t prepare for force majeure events such as natural disasters and, in some cases, major strikes across entire sectors, wars are usually predictable because of the growing geopolitical tension that precedes them. Because wars are accompanied by risk aversion and safe-haven demand, traders who foresee the outbreak of war can protect their capital by investing in safe-haven currencies (Swiss franc, Japanese yen) in a timely manner.
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Being among the first to sell a higher-yielding currency and buy Swiss francs during a war can earn you a high return, as the thousands of traders who follow your move will trigger a strong rally in the safe-haven currency, boosting your capital. At the same time, market players who are late to exit their long positions in higher-yielding currencies may experience dramatic losses. For example, the US dollar lost almost 10% against the Swiss franc in the three months leading up to the war in Iraq, owing to the military intervention’s international unpopularity.
Terrorist attacks are powerful market movers as well, but their force-majeure nature makes them unpredictable and impossible to trade profitably in advance. However, being informed in time, using capital protection tools (such as protective stops) and relocating your capital from riskier currencies to safe-haven ones can make the difference between losing most of your money and retaining it, or even profiting from the event.
Considerable attention is also paid to G7 meetings because the seven members – Canada, France, Germany, Italy, Japan, the United Kingdom and the United States – together represent more than 63% of net global wealth, according to Credit Suisse’s October 2013 Global Wealth Report. Not all G7 meetings are market movers, but when the member countries’ finance ministers are expected to announce significant changes, broad market volatility is almost always observed.
Elections, broad sector strikes, debt default
Elections in major economies are closely monitored, especially at times of political instability, because the new government or president who steps into power may introduce different policies and steer the economy in a new direction. In general, political instability and the possibility of an unpopular contender winning the elections cause a depreciation of the national currency, which in turn favours selling it.
Traders usually keep track of pre-election polls to get a general idea of what is about to come and how to position accordingly. This is why currency fluctuations are usually observed not only after the elections, but also during the campaign.
Another event worth considering is an unscheduled election. These are held if a government or president resigns, or following a successful no-confidence vote or a presidential impeachment procedure. Usually, a resignation comes as a result of the government’s or president’s inability to fulfil their obligations to the electorate, as well as corruption scandals, protests, etc.
Nationwide protests and sector strikes can be a decisive factor for a government to resign as they spur economic uncertainty, which in turn may lead to a downgrade of the country’s sovereign credit rating. Just imagine what implications for the economy a nationwide strike of healthcare employees would cause, or if transportation labour unions decided to walk out even for just a day.
Debt default
The worst-case scenario for a national currency is a sovereign default (national insolvency). There are different measures a government can take to avoid defaulting. However, even if it manages to do so, the resulting uncertainty will already have forced its creditors to require higher interest rates for the additional risk they have taken. Moreover, because sovereign defaults, especially among the more developed economies, are a rare event, the majority of investors who have turned to government bonds as investment vehicles are less risk-prone (they have a higher level of risk aversion). Therefore, the possibility of default will significantly reduce the number of people who would want to lend money to this country, reducing capital inflows and demand for the local currency, which in turn will depreciate it.
Apart from the decline in incoming money flows, the economy will also suffer an outflow of capital as investors choose to invest elsewhere. Domestic demand will also falter as the monetary wealth of many individual investors declines, further deepening the economic crisis. Depending on the banking system’s stability and its style of lending (aggressive or more conservative), a banking crisis may also occur as banks will need to write down loans extended to the state. Needless to say, any sign of a country’s inability to pay interest on the capital it has attracted is factored in immediately on the financial markets, and being late in positioning yourself accordingly as an individual trader could incur significant losses.