The impact of politics on the foreign exchange market (2024)

The foreign currency (FOREX) market is subject to substantial impact from politics, which plays a key part in setting trends, volatility, and investor mood. The nature of this relationship is complex and diverse, frequently influenced by a range of political occurrences, policies, and geopolitical strains. Multiple instances exist that demonstrate the influence of politics on the FOREX market.

Monetary policy and central banks are two key areas of focus. Central banks’ monetary policies are influenced by political actions, which in turn impact interest rates and the money supply. The statements made by central banks, such as adjustments in interest rates or the implementation of quantitative easing initiatives, have the potential to induce swings in currency values due to their influence on market perceptions pertaining to economic growth and inflation.

Furthermore, economic policies. The economic policies implemented by political leaders, including fiscal stimulus packages, taxation measures, and trade agreements, have the potential to exert an influence on a nation’s trade balance, inflation rate, and general economic well-being. The presence of uncertainty over these policies can result in fluctuations in currency markets as investors evaluate possible outcomes and make necessary adjustments to their positions.

Next, the topic of geopolitical tensions. The FOREX market may experience uncertainty and risk aversion as a result of geopolitical events, like hostilities, trade disputes, or diplomatic difficulties. During times of geopolitical turmoil, safe-haven currencies such as the US dollar, Swiss franc, or Japanese yen tend to appreciate as investors seek shelter from more volatile assets.

Furthermore, the topic of interest is election cycles. Currency markets may experience uncertainty during elections and political transitions, especially if there is a potential for substantial policy changes. Election campaigns and opinion polls are regularly monitored by currency traders in order to evaluate prospective outcomes and analyze their potential impact on exchange rates.

Furthermore, the concept of centralized intervention is being considered. Certain governments may engage in direct intervention in the foreign exchange (FOREX) market with the aim of stabilizing their currencies or attaining specific economic goals. The impact of central bank actions, such as the purchase or sale of currencies, on exchange rates and market sentiment can vary in terms of effectiveness.

The topic of interest is market sentiment and perception. The market sentiment and investor opinion of a country’s economic prospects can be influenced by political events and changes. Favorable political advancements, such as effective policy reforms or diplomatic successes, have the potential to enhance trust in a currency, whilst unfavorable occurrences may result in currency selloffs and devaluation.

Politics exerts a significant influence on the dynamics of the foreign exchange (FOREX) market, as political events and choices serve as critical catalysts for currency fluctuations and investor conduct. Traders must be watchful and adjust to changing political environments in order to effectively manage the intricacies of the currency markets.

The study conducted by Moore and Mukherjee (2006) in their publication titled “Coalition government formation and foreign exchange markets: theory and evidence from Europe” in the International Studies Quarterly highlights the substantial impact of politics on the dynamics of the foreign currency (FOREX) markets. The establishment of coalition governments has the potential to bring political uncertainty, which in turn can have an impact on the trading behavior of currency dealers, ultimately influencing the volatility of exchange rates.

In their research titled “The currency composition of sovereign debt” published in the American Economic Journal Macroeconomics (2019), Ottonello & Perez highlighted the significant influence of governments in determining the currency composition of sovereign debt. They emphasized the importance of governments in managing inflationary costs and hedging properties.

Cumperayot and Kouwenberg (2021) assert in their publication titled “Cheaper currencies and long term growth: the effect of exchange rate management and capital controls” that the growth implications of maintaining a currency at a lower value can be influenced by government interventions, including exchange rate management and capital controls.

According to Biwas et al. (2023), in their publication titled “Forecasting the United States Dollar (USD)/Bangladeshi Taka (BDT) Exchange Rate with Deep Learning Models: Incorporation of Macroeconomic Factors Affecting Currency Exchange Rates” on Plos One, exchange rate regimes are frequently shaped by political determinations. Floating exchange rates are determined by market forces of supply and demand, whereas fixed or pegged rates are established and upheld by governments or central banks.

According to Conrad and Jagessar (2018), in their article titled “Real exchange rate misalignment and economic growth: the case of Trinidad and Tobago,” politicians may propose reducing exchange rates as a means to foster economic growth. However, economists maintain a skeptical stance regarding the potential long-term consequences of implementing such measures.

Furthermore, the export potential of a nation can be significantly influenced by government policies, specifically currency regulation. This influence can have a direct impact on the country’s presence in foreign markets, as outlined by Sandoyan and Galstyan in their publication titled “The impact of currency regulation policy on the country’s export potential: the case of Armenia” in the journal Finance Theory and Practice (2020).

Youness (2022) examines the effects of political uncertainty on currency exchange rates in their study titled “The impacts of political uncertainty on the currency exchange rate.” Studies examining the correlation between politics and exchange rates have shown that political uncertainty can also impact currency exchange rates.

Popoole et al. (2022) conducted a study titled “Exchange rate policy regimes, private investment behavior and economic growth in Nigeria (1960-2020)” which was published in the journal Financial Markets Institutions and Risks. The study highlights that the selection of an exchange rate regime, such as fixed, floating, or managed-floating, is influenced by government policies and can potentially impact economic growth.

In addition, Frieden et al. (2005) argue in their publication titled “Sustaining fixed rates: the political economy of currency pegs in Latin America” that the influence of political choices on currency pegs in various regions, such as Latin America, underscores the intricate relationship between political elements and the stability of exchange rates.

In conclusion, the impact of politics on foreign exchange (FOREX) markets is significant, manifesting through several mechanisms such as government interventions, exchange rate regimes, and political instability. Comprehending the complexity of global financial systems and their interconnectivity with political decision-making processes requires a thorough understanding of the delicate interaction between politics and currency markets.

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