by Vicki Schmelzer
The word “geopolitics” comes from two Greek words Γῆ (earth) and Πολιτική (politics). The dictionary definition (Merriam-Webster) says “the study of how geography and economics have an influence on politics and on the relations between nations.” In the Forex market, however, traders tend to reverse this definition and look at how events unfolding in the political arena or between countries affect financial markets, whether in a single given country or globally.
Under the umbrella of geopolitical events, there are many categories, ranging from local elections to budget negotiations and referendums to missile launches. Sometimes, these happenings fly below the FX market’s radar and other times, these events have a sizable effect.
Elections can either be exciting or ho-hum events. A clear example of the former would be the 2012 US presidential election where incumbent President Barack Obama squared off against Republican candidate Mitt Romney. In this situation, the financial market had one view of what would be best for the US economy and the rest of the world had another. A MarketWatch poll, taken just ahead of the election, asked financially minded readers who they planned to vote for. Of 11,935 votes cast, 62.4% were for Romney and the Republicans, 32.9% were for Obama and the Democrats and 4.6% were for a split ticket. In contrast, a pre-election poll, taken by The Economist magazine asking global readers who they thought should be the next US president, showed that 79.51% favored Obama, 19.91% Romney and 0.58% unknown.
The US financial market clearly favored Romney. Heading into the election, the thinking was that a Romney presidency would mean less government regulation and more fiscal prudence. There was talk also of an early end to the Federal Reserve’s quantitative easing, with rising US Treasury yields likely to lift the dollar.
Because the race was so tight, FX traders were reluctant to position into Election Day November 6, 2012. Nevertheless, US Treasury yields and the dollar were underpinned by the prospects of a Romney win. Many were sorely disappointed in the election result, and yields and the dollar saw a knee-jerk tumble. Later in the month, fiscal cliff jitters led to safe-haven demand for US Treasuries and the dollar again firmed despite falling US yields.
However, elections and scandals involving politicians do not always affect Forex. The Lewinsky scandal barely affected the dollar. Japanese elections hardly ever affect the yen. When Chancellor Merkel was reelected in 2013, a new government was not actually formed for months and the euro did not respond to the delay.
In the 2016 US presidential election, the entire polling universe had Democrat Hillary Clinton with a 95%+ probability of winning. Markets were calm and focused entirely on an upcoming fed rate hike. But the US electorate surprised the world by choosing Donald Trump, widely considered erratic and unqualified. Markets started falling the minute the election results were in, including the S&P stock index down over 500 points and the dollar crashing. EUR/USD spiked from 1.0987 to 1.1300 in the space of five hours. But within a week, financial analysts and traders had changed their tune, seeing a Trump presidency as bringing tax cuts, higher government spending, deregulation and other pro-growth policies. Markets more than recovered — they overshot the other way. Rising inflation expectations caused the 10-year note yield to soar from 1.828% the day before the election to over 2.30% a week later. EUR/USD fell from the spike high at 1.1300 to 1.0760 in the following week, or a dollar gain of over 500 points. This was a case in which shock should be spelled with a capital S.
Domestic events can have far-reaching effects on world financial markets, especially if the domestic event is in a G7 country. US budget negotiations in October 2013 were so contentious that global investors did not know how to hedge against a bad outcome. In prior times of global and or US uncertainty, the market felt comfortable buying US Treasuries and the dollar. In October 2013, however, there was a sense that this time might be different, especially with the debt ceiling looming. German Bunds and Japanese Government Bonds were purchased as an alternative, keeping the major currencies rangebound.
The word “referendum” tends to evoke Europe, which has seen numerous referenda over the years, many of which have had global ramifications. Denmark’s referendum about whether or not to join the eurozone in September 2000 rattled FX markets. The euro currency fell ahead of the vote and then continued to fall thereafter. The decline was deemed worrisome enough that in late September 2000, global central banks (the Federal Reserve, European Central Bank, Bank of Japan, Bank of Canada, and Bank of England) bought €1.5 billion to stem euro weakness. Forex market intervention, and especially joint, coordinated intervention by G7 countries, is the very pinnacle of a geopolitical event.
In 2014, the Crimea referendum saw heavy selling of both Ukrainain hryvnias as well as Russian rubles against the dollar and the euro, which were deemed safe haven currencies. The worst of the selling was seen ahead of the referendum, with hryvnias and rubles firming after the well-heralded results. The Russians had intervened early in the process to prop up the ruble, but it is hard to say that this event alone contaminated emerging markets, which were seeing intervention in Turkey and elsewhere at the same time.
In 2016, Brexit referendum, with its widely unexpected outcome, resulted in a 10% loss of the British pound versus the US dollar in a single trading session, breaking the previous record of GBP/USD depreciation since the Black Wednesday of 1992.
But in contrast, the semi-annual meetings by G7 and G20 hardly ever result in a “geopolitical event.” Once, in the 1990’s, a Japanese finance ministry official commented that Japan could withdraw support from the dollar by selling some of its massive reserves — he halted his flight home in Guam to apologize and retract the comment. In the 2000’s, then Treasury Secretary John Snow called on China to un-fix the renminbi. This was the first time the subject was brought up in such a public venue, and it set off a ruckus. Not long afterward, China did indeed unpeg the currency.
More powerful, usually, are the semi-annual IMF meetings, accompanied by economic forecasts for every country and region in a report named the “World Economic Outlook.” This is a regularly scheduled economic report and should not be considered a geopolitical event except that the IMF in recent years has taken the liberty of commenting on politics and central bank bias and behavior, chiding both the Bank of Japan and the ECB for allowing deflationary conditions to develop. Comments on the sidelines of G7, G20, and IMF meetings are often geopolitical, even if of fleeting importance.
Any suggestion of military conflict tends to make global investor risk averse and flocking to what they perceive is a safe haven. With the US Treasury market the most liquid and deep bond market in the world, it comes as no surprise to see Treasuries in hot demand in times of such uncertainty. But the greenback is not always the beneficiary of Treasury demand since global investors might merely move money out of stocks and other instruments into bonds, with no Forex effect. The currency of the country in question is not always the big loser in case of military escalation. In October 2006, when North Korea had just conducted a nuclear test and the United Nations had imposed political sanctions, the South Korean won fell sharply. But it was the yen, seen as a proxy for less liquid Asian currencies, which came under fierce downward pressure versus the dollar and on the crosses. As North Korea returned to Six Party talks a few weeks later, Korean stocks and the Korean won, as well as the yen, rallied.
There are times when several geopolitical events occur simultaneously and cause financial markets to become severely risk averse. In September 2006, the market was worried about potential spillover effects stemming from the hedge fund Amaranth Advisors hefty ($6+ billion) losses in the natural gas futures market. At the same time, there was a new scandal in Brazil regarding an aid of President Luiz Inacio “Lula” da Silva and there were jitters about a default in Ecuador. Added to the mix were efforts to bring trade sanctions against China and a military coup in Thailand. Brazil’s Bovespa and the Brazilian real fell sharply, and there was widespread exodus out of Latin American markets overall. Asian markets were jittery. This is a good example of the “contagion effect,” whereby a whole sector (emerging markets) can be affected by developments in just a few countries, but those few countries seen as critical mass. In this instance, and indeed in most instances when emerging markets look riskier than usual, the dollar rose due to safe haven demand.
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