The foreign exchange, or forex market is the biggest and most active financial market in the world. Everyday participants from all over the world engage in over $4 trillion worth of foreign exchange transactions. With the forex market being such a global and inter-connected marketplace, events from all corners of the globe can have an immediate effect on exchange rates and currency values. Here we will discuss a few typical global events that often occur, and how they may influence the forex market. (Learn how to set up a trading plan using this method, to profit as a forex trader. Check out Using Elliott Wave To Trade Forex Markets.)
TUTORIAL: Economic Indicators To Know
An election - a common event in almost every nation - can have a large impact on a country's currency. Elections can be viewed by traders as an isolated case of potential political instability and uncertainty, which typically equates to greater volatility in the value of a country's currency. In most situations, forex participants will simply keep an eye on pre-election polls to get a sense of what to expect, especially looking for any type of change at the top. A change in government often means a change in ideology for the country's citizens, which usually means a different approach to monetary or fiscal policy, both of which, especially the former, are big drivers of a currency's value. Additionally, political parties or individuals who are seen as more fiscally responsible or more concerned with promoting economic growth tend to boost a currency's relative value. So in the case where an incumbent who is seen as "pro economy" is in danger of losing his or her position of power, traders may sell out of the currency for fears of limited future economic growth and predictability.
Another circumstance of great importance is an unexpected election. Whether it comes via a non-confidence vote, corruption scandals or other situation, unplanned elections can wreak havoc on a currency. Especially in cases where upheaval among citizens results in protests, work stoppages, etc. Such events cause great uncertainty in countries and increased political instability. Even in cases where an autocratic government is being challenged in favor of a new, more democratic and economically open-minded government, forex traders don't like the uncertainty caused by such protests. In most situations, the political instability will outweigh any positive anticipated outcomes from a new government in the short run and related currencies will usually suffer losses. In the long-term, however, basic valuation factors and principals will once again apply and currencies should settle at or around a rate indicative of the country's economic growth prospects. (Investing overseas begins with a determination of the risk of the country's investment climate. See Evaluating Country Risk For International Investing.)
The fallout from a natural disaster can be catastrophic for a country. Disasters such as earthquakes, floods, tornados and hurricanes harm a country's citizens, morale and infrastructure. Additionally, such disasters will also have a negative effect on a nation's currency. The loss of life, damage to major factories and distribution centers, in addition to the uncertainty that inevitably come with natural disasters, are all bad news for a currency.
Infrastructure damage is a key concern due to the fact that basic infrastructure is the backbone of any economy, and breaks in that infrastructure can severely limit the economic output of a region. Furthermore, the additional costs that are incurred to clean up and rebuild after a disaster takes away from government and private spending that could have been used towards economically advantageous ventures, rather than towards patching up a break in the value chain from damages in infrastructure. Add to this a probable decrease in consumer spending due to the economic uncertainty and a possible loss of consumer confidence, and any economic strengths can be turned into economic weaknesses, especially when compared to other nations that may prosper from the other's loss by filling the needs of those unable to import goods or services from the disaster stricken nation. All in all, a natural disaster will almost surely hit an economy's currency hard.
Here we're not talking about a currency war - in which countries actively attempt to devalue their currencies to aide their domestic economies in global export trading. We're discussing the impact of a physical war on forex, and it usually isn't pretty. Much like a natural disaster, the impact of war is brutal and widespread. As discussed with disasters, the damage to infrastructure deals a huge blow to a nation's short-term economic viability, costing citizens and governments billions, most of which must be borrowed. War rebuilding efforts must often be financed with cheap capital resulting from lower interest rates, which inevitably decrease the value of a domestic currency. Add to this the complete uncertainty surrounding such conflicts, on not only future expectations but on a day-to-day basis as well. Volatility of currencies actively at war are typically much higher than those not involved in a confrontation.
One aspect that some economists point to, however, is the potential economic upside to war. War at times can kick-start a fledgling economy, especially its manufacturing base, when forced to concentrate its efforts on war time production. Think of the United States in World War II. The U.S.'s entry into the war following the attacks on Pearl Harbor almost instantly pulled the country out of the grips of the Great Depression. While there is historical precedent for this viewpoint, most would agree that an improved economy at the cost of human lives is not a choice most would be willing to make. (After World War II, Germany was in ruins. Learn about the country's quick rise to the third strongest economy in the world. Refer to The German Economic Miracle.)
The Bottom Line
These are just a few events that can have a profound effect on the currency markets. As you can see, the key points to take from this discussion is that much of a currency's value is derived from the economic strength of the nation, and any unforeseen uncertainty to predictable future forecasts of economic outputs will typically not work in a currency's favor. While it is very difficult to plan for the unexpected in the forex market, an informed trader will be quicker to react to global events than one who is unsure of what moves to make in their wake.