From trade wars to elections: The impact of global events on exchange rates

The foreign exchange market, or Forex market, is the world's largest financial arena, with over 6,000 billion dollars worth of transactions taking place every day. Its unrivalled liquidity, essential for international trade and investment, exposes investors to extreme volatility - the market's main difficulty. Forex is attractive for its huge profit potential for those who can skilfully navigate its fluctuations. Indeed, savvy investors can make significant profits by correctly anticipating currency movements.

Influenced by global events such as Brexit in 2016 and the Sino-US trade war, the Forex is subject to rapid currency fluctuations, making forecasting difficult and investment strategies vulnerable. These events have shown how quickly exchange rates can fluctuate, requiring careful analysis and risk management. Understanding these processes is important for investors, traders and economists as it allows them to predict changes in currency markets and adapt strategies for successful trading.

Political influence on exchange rates

Political events and decisions play a key role in the dynamics of exchange rates. These factors can significantly affect investor confidence and the economic stability of countries, which in turn affects the value of their currencies.

Elections and changes in government can lead to significant volatility in exchange rates. For example, the political instability seen during the Brexit negotiations had a significant impact on the GBP/USD exchange rate. The result of the Brexit referendum was announced on 24 June 2016. On that day, the Pound Sterling (GBP) exchange rate fell sharply from 1.50 to 1.32 dollars due to the political and economic uncertainty caused by the vote in favour of the United Kingdom's exit from the European Union.

Similarly, tensions between the United States and North Korea (2017) caused the dollars to decline. These events create uncertainty that causes investors to react, often preemptively, resulting in fluctuations in the currency converter and the price of currencies in the foreign exchange market.

Impact of trade policy and other factors

Trade negotiations, including trade wars and trade agreements, also have a significant impact on currencies. For example, the trade war between the US and China (2018-2019) caused the Chinese yuan to fall, which affected the euro to dollar exchange rate. During this period, a number of reciprocal tariffs were announced between the two countries. Overall, the RMB exchange rate fluctuated around CNY 6.3 to CNY 7.0 per USD 1 during this period, compared to CNY 7.2 per USD 1 in February 2024.

Natural disasters, while not in the policy realm, can also have significant economic and political consequences by affecting exchange rates. For example, the earthquake and tsunami in Japan in 2011 caused the Japanese yen to fall. The yen initially fell in the first days after the disaster, but then rose rapidly on expectations of large-scale repatriation of recovery funds by Japanese companies. The USD/JPY fell from 83 yen to 76 yen per dollars in the weeks following the disaster.

Economic and social implications for world currencies

Exchange rate fluctuations play an important role in the global economy, affecting trade, investment, debt and financial markets. A depreciating currency can make exports more competitive but increases the cost of imports, leading to inflation. This can attract foreign direct investment, but also cause capital outflows if it falls too far. For countries with external debt, currency depreciation increases the debt burden by requiring more local currency to service the debt.

At the social level, currency depreciation increases the price of imported goods, worsening living standards and lowering real wages. Economic instability can increase migration flows and reduce government spending on social programmes.

Economic and social factors

Expectations of inflation and interest rates have a direct impact on exchange rates. When investors expect inflation to rise, central banks may react by raising interest rates to contain inflation. For example, if the Eurozone is forecast to raise interest rates in response to rising inflation, this may cause the Euro to appreciate against the EU dollars.

Higher interest rates make euro-denominated assets more attractive to investors because they provide higher returns. As a result, investors may shift their funds from U.S. assets to European assets, which increases demand for the euro and its value relative to dollars. This process illustrates how central banks' expectations and actions affect currency markets.

In addition, social and political factors can also have a significant impact on exchange rates. Political stability, confidence in government action, and public sentiment can both strengthen and weaken a currency. For example, positive economic reforms and political stability in a country can increase investor confidence and strengthen a nation's currency. Conversely, political instability or ineffective economic measures can lead to capital outflows and currency depreciation.

Financial crises

Financial crises are a vivid illustration of how economic turmoil can directly affect exchange rates. An example of this is the Asian financial crisis of 1997. During this period, the loss of confidence in the currencies of a number of Asian countries such as Thailand, Indonesia and South Korea caused them to plummet. Investors began to withdraw their capital from these countries en masse, fearing economic instability and further depreciation of assets.

At the same time, currencies that were considered safe havens, such as the dollars and the Japanese yen, strengthened. This trend is attributed to investors fleeing to assets that are considered more stable and reliable during times of economic turmoil. Investors prefer to move their funds into currencies and assets of countries with more stable economic and political situations, which increases the demand for these currencies and leads to their appreciation.

Monetary policy

The interaction between exchange rates and monetary policy also shows how central bank decisions based on economic indicators such as inflation and GDP directly affect the value of currencies. The depreciation of the euro against the dollars (1 dollar is equivalent to 0.95 euros in 2002) after the introduction of the single European currency (2002), despite low inflation (1.4 per cent) and a trade surplus in the euro area, demonstrates the complexity of the forces at work. The depreciation of the euro against the dollars, despite low inflation and a trade surplus in the euro area, can be attributed to differences in monetary policy and market expectations favouring the dollars. These factors may have led investors to favour the dollars, which is considered safer and offers better return prospects.

Conclusion

Exchange rates are influenced by many factors - these elements, interacting with inflation and monetary policy, cause significant fluctuations in exchange rates. Inflation, in particular, can weaken the value of a currency, while the main factors that determine exchange rates are interest rate differentials, trade balance and capital flows. These factors help traders to thrive in an ever-changing economic environment. The ability to analyse political and economic events, predict their impact on exchange rates and adapt their strategies is what makes a successful Forex trader in the Forex market.