Political events, Natural disasters, War
This lesson will cover the following
- Political events
- Natural disasters and war
- Impact on exchange rates
Because the Forex market is a global, complex and interconnected marketplace, events occurring anywhere in the world can immediately affect currency exchange rates. In this article, we shall discuss several events that frequently take place worldwide and consider how they may influence the Forex market.
Political events
Elections, which take place in almost every nation, can have a huge impact on the local currency. Such events may be viewed by traders and analysts as isolated incidents signalling political instability, which usually triggers heightened volatility in the local currency. In most cases, Forex traders simply follow pre-election polls to gain an idea of what is to come. If a country’s government is expected to change, this may imply that new ideologies and new monetary or fiscal policies will be proposed and implemented, potentially becoming a strong driving force behind the value of the currency.
Another scenario worth mentioning is an unexpected election. Whether it occurs as a result of a vote of no confidence, corruption scandals or other developments, such sudden, unanticipated elections can create turmoil in the currency market. A particularly notable case is an uprising among a country’s citizens. Such a situation may lead to protests, walk-outs and even more extreme forms of civil unrest. These events can shake the foundations of a country, creating economic uncertainty, potential credit-rating downgrades and greater political instability.
Instability in a country’s political system may negate any anticipated short-term benefits from a newly elected government, while the national currency may come under heavy selling pressure. In the longer term, however, such disturbances are generally expected to subside, and the national currency may stabilise near exchange rates that reflect the country’s economic growth outlook.
Natural disasters
Natural disasters and wars often have a catastrophic effect on currency values. The morale and infrastructure of a country can be severely damaged by events such as floods, tornadoes, earthquakes and hurricanes, and these disasters usually exert the same negative pressure on the nation’s currency.
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Examples
Such examples include the earthquakes in Japan and New Zealand and their effect on the respective currencies. Initially, the currencies weakened because of the damage inflicted on the economies. They then strengthened as insurance funds were transferred from overseas to finance repairs. Afterwards, the currencies declined again following the actions taken by their central banks. The banks sought to spur economic recovery by injecting additional liquidity into the financial system and by reducing interest rates, a move that adversely affected both currencies.
Another example that illustrates this point is the triple calamity in Japan in 2011 (an earthquake, a tsunami and a nuclear disaster), which dealt a severe blow to the local economy and also affected the global economy. Basic infrastructure forms the cornerstone of any economy; therefore, damage to, or complete destruction of, infrastructure can severely curtail the economic output of a given region. Moreover, a possible reduction in consumer spending triggered by economic uncertainty, a probable decline in consumer confidence, and the erosion of any competitive advantage the country may possess pave the way for economic catastrophe. This becomes especially evident when the affected nation is compared with other countries that prosper from its misfortune.
War
Similar to natural disasters, the impact of war on the economy is almost always wide-ranging. As noted above, damage to infrastructure suffocates a nation’s short-term economic viability, potentially costing citizens and the government billions. A large proportion of these funds typically needs to be borrowed. An economy ravaged by war usually needs to be rebuilt with the aid of low-cost capital, which is facilitated by lower interest rates. This inevitably leads to a devaluation of the local currency.
What conclusion can be drawn? In most such cases there is profound uncertainty about both future prospects and the day-to-day evolution of the situation. The volatility of currencies of nations involved in war is markedly higher than that of currencies belonging to countries that remain outside the conflict.
However, analysts highlight another aspect – the potential economic gains from war. Sometimes conflict can bolster a nascent economy, and in particular the manufacturing sector, if it is compelled to concentrate its capacity on wartime production.