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Geopolitical shocks and currencies

08-15-2022 at 02:18:11 AM

Geopolitical shocks and currencies

Geopolitical shocks and currencies



At the time of writing, tensions between Russia and Ukraine had bubbled over into real conflict, with Russian troops advancing on Ukraine’s major cities on February 24.To get more news about Hantec亨达国际金融, you can visit wikifx.com official website.

When major geopolitical tensions emerge, FX markets are impacted. Although the issues can be wide-ranging, from trade wars, to changes in political leadership and pandemics, the resulting volatility in currency markets often follows broad trends. Here, we explain how the situation in Russia-Ukraine fits with this playbook.In response to recent aggressions against Ukraine, a number of world leaders from a growing number of countries including the US, Australia, Japan and UK have applied sanctions on Russia to exert political and financial pressure.
By the end of February, the global payments messaging system, SWIFT, which banks use to transact internationally had been cut off to a number of Russian banks, and crucially the Russian central bank, meaning hundreds of billions of dollars of foreign reserves are now inaccessible.1

Europe has severed ties with some Russian energy suppliers — Germany halted approval of the soon-to-be opened Nord Stream 2 gas pipeline from Russia on February 24, and Finnish and Swedish refiners have suspended purchases of Russian oil.2 Perhaps as importantly, oil traders are shunning highly discounted Russian crude for fear of not being able to transact due to payment sanctions, and are instead opting to buy Middle Eastern crude at inflated prices.

These developments, among others, have massive ramifications for the global economy, and because of this environment of uncertainty, investors are looking to preserve capital in safe markets.
Markets hate uncertainty. Some traders like some volatility — enough to make a few percent here or there — but overall the big players put a lot of time and effort into building financial models with mostly predictable inputs like a country’s growth rate, inflation settings, and for equity markets, consumer trends, a company’s capital investments etc.

All financial models factor in a bit of risk in case they missed something in their assumptions, or some unforeseen event occurs, but major conflagrations are a different story. Events like global conflict are very difficult to model, certainly in the short term as things move so quickly. This can force investors to make the difficult call to hold onto a position and hope that things settle down, or take early losses before markets fall further.

Generally, once broad-based selling occurs, the herd mentality common to markets takes effect and the financial impact can be pronounced.

For example, in June 2016, when the UK voted on leaving the EU, the pound saw an unprecedented drop in value as soon as it became clear that the ‘leave’ campaign had won. The currency plummeted from a high of 1.50 USD to under 1.33 USD, dropping more than 10% in just one day. Shockwaves reverberated around the global economy, with huge sell offs across global equity markets and risk assets, based on the uncertainty of the shift in geopolitical order.In the midst of a crisis, it can feel like the beginning of a long, drawn out period of volatility. It’s human nature to forget the lessons of the past and place more emphasis on the present.

But in reality, the time between a crisis and its nadir from an investment perspective is usually relatively short.

With a bias towards negative news, markets will always be watching for geopolitical situations that might escalate, and even if they come to nothing, the perceived risk could still impact a country’s currency.

For example, during the final round of the French election in 2017, right-wing candidate Marine Le Pen wanted to abandon the euro and return to the franc. Despite the fact she was an outside chance to win, this was enough to make markets nervous based on the potential blow to the cohesion of the European Union and greater geopolitical uncertainty. However, when pro-euro Macron was confirmed as the winner, investor confidence returned and the euro swiftly recovered its losses in a relief rally, reaching 6 month highs against USD, and then going on to gain around 10% in the 4 months following.

When uncertainty is resolved quickly, geopolitical events can end up being just a blip and can have little bearing on a currency. However, if uncertainty is drawn out, this can lead to extended periods of downward pressure.

In the case of Brexit, after the shock of the initial vote shook markets, the geopolitical tensions and uncertainty around trade deals was drawn out over three and a half years. During that time headlines around negotiation sticking points and missed deadlines created bursts of volatility and downward pressure on the pound. Eventually, once the final deal was struck at the end of 2019 a rally saw the pound recoup some of its losses.

Poetry is what gets lost in translation.

Robert Frost (1875-1963) American Poet.