The global forex market remains a highly lucrative entity, with its cumulative value estimated to be in the region of $2.409 quadrillion. This is a truly staggering sum, and one that has risen exponentially throughout the digital age.
Forex is also an incredibly volatile entity, with currency prices vulnerable to a large and diverse range of factors. Many of these are related to the aggregate economy, with factors such as the trade flows between specific nations impacting the value of each respective currency.
However, there are less tangible factors that impact the forex market, with politics offering a relevant case in point. But how exactly does politics influence international currency values, and is its impact greater than macroeconomic factors?
What Factors Impact the Forex Market?
As I’ve already touched on, there’s a particularly large range of factors that impact currency values and the wider forex market. These can be broadly separated into two distinct categories, including factors that are related to the economy and those that aren’t.
- Macroeconomic Factors: Macroeconomics is a branch of economics that studies the behaviour of the aggregate economy. It therefore focuses on a number of key individual factors, including trade flows, unemployment, GDP growth, inflation and interest rates. These typically have a direct impact on currency values and the prevailing demand, with rising inflation known to erode the purchasing power of affected currencies and reduce interest from overseas investors. Higher interest rates can counter this in some respects, they enjoy an inverse historical relationship with inflation.
- Non-Macroeconomic Factors: In some respects, the category for non-macroeconomic factors is even broader, as this includes any influential metric that isn’t directly associated with the economy. These include major events such as Olympics or global pandemics, along with natural disasters and acts of terrorism. However, geopolitical events like elections and diplomatic relations are by far the most impactful non-macroeconomic factors, while aforementioned metrics such as trade flows also blur the lines between these two categories.
Appraising the Impact of Politics on Forex
Ultimately, both economic and political factors impact on currency values, while both entities and criteria can be used to construct and inform the best forex signals.
However, the most obvious distinction between these categories is the way in which they impact currency values and demand. For example, macroeconomic factors (like interest and inflation rate changes) tend to have a more marked and direct impact on forex, although their effects are relatively short lived.
Conversely, political and non-macroeconomic factors can have a much more subtle and less direct impact on currency prices. Such factors can last much longer, however, while they’re often hard to pre-empt and may involve a much larger number of variables.
For example, rising geopolitical tensions between two nations can last for months and years, while such breakdowns in relationships are incredibly unpredictable and can develop in a number of different ways. Interestingly, conflicts of this type can also affect the allies of afflicted nations and global trade, creating a scenario where political factors have a long-term impact on the macroeconomy.
If you directly compare macroeconomic and political factors, you’ll see that the former largely enjoy measurable relationships and are underpinned by deterministic and predictable factors. This is clearly not the case with the latter, which can vary wildly in nature and subsequently have a dramatic impact on economic and monetary policy.
The Last Word – Are Political Factors More Impactful than Macroeconomic Alternatives?
Ultimately, the impact of macroeconomic factors on forex is more direct, measurable and shorter lived, while there are actionable ways in which investors can negate these and even leverage them to their advantage.
Conversely, political factors tend to be much longer lasting and variable, while their evolution and impact can be much harder to predict and circumnavigate through investment strategies.
There are exceptions to both rules, of course, as national elections last for a predetermined period of time and will have more predictable impacts depending on which candidate wins (and their proposed economic policies). Broadly speaking, however, political factors can prove more impactful over time, even having a subsequent impact on the macroeconomy and monetary policy deployed by governments.
The best recent example was provided by the coronavirus pandemic, which persisted for well over a year in the developed world and saw the temporary cessation of economic activity in some markets. The long-lasting impact of Covid-19 continues to affect the global supply chain and is a key contributor to current inflation hikes, and this trend shows no sign of abating any time soon.