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Move over economic analysis and risk sentiment! Politics has turned out to be one of the bigger drivers of forex price action lately so it’s about time we take a look at how this could affect the industry.

As Forex Gump discussed in his article on the 4 Reasons Why Politics is Upstaging Monetary Policy, currency movements seem to be more sensitive to headlines on Trump, Brexit, the French elections, and more Trump rather than monetary policy announcements these days. One of the top explanations for this is that central banks have pretty much used up all their easing tools in boosting liquidity and cutting interest rates to historic lows, which suggests that they may be running out of moves. Because of that, economies and market watchers are turning their attention to government fiscal policy for stimulus.

major central bank interest rates
Source: FactSet

However, it’s also worth noting that this phenomenon has been more evident in the West, which appears to be seeing the brunt of political upheavals so far. In contrast, economies like Australia and emerging nations in Asia appear to be taking their cues from China’s economic outlook, although this is also influenced by local politics and possibly by – surprise, surprise – U.S. President Trump later on.

I’m sure you’re thinking that there have been a few recent instances in which central bankers have led to big moves in the forex charts, particularly BOE official Kristin Forbes’ remarks on a potential rate hike to keep U.K. inflation in check or Fed head honcho Yellen’s comments on tightening sooner rather than later. Looking at longer-term time frames, however, reveals that price reactions to these monetary policy hints tend to be short-lived in comparison to major political happenings.

Dollar index Trump Yellen Draghi
Source: Heisenberg Report

As The Heisenberg (Nope, not the guy from Breaking Bad! Or is he?) wrote in his blog entry on how it’s time to start worrying about FX volatility, all the uncertainty going around the markets is causing the divide between monetary policy and politics to disappear.

“Indeed, political expediency may require that the two be merged. That could make it decidedly difficult for FX markets to determine who’s ultimately in charge and whose comments should be given the most weight,” he points out.

In line with this, forex intervention concerns have also been revived recently, owing to the Donald’s calling out of Japan and China for unfairly keeping their respective currencies weak. But some analysts have pointed out that this in itself is a form of jawboning, leading many to speculate that Trump could continue to push for a weaker U.S. dollar and undermine the impact of potential Fed rate hikes.

In Europe, ECB head Draghi’s downplaying of inflation gains and hints of QE expansion in anticipation of further economic uncertainty in the region have kept SNB officials and franc traders on intervention watch. After all, the Swiss central bank is notorious for stepping in the markets to engineer franc depreciation. They might even reinstate the EUR/CHF peg if they deem it necessary!

At the end of the day, though, it’s important to remember that fundamental analysis revolves mostly on economic performance, which is in turn largely affected by politics. We’ve seen this happen to some extent in previous years (Remember the U.K. hung parliament woes? How about the U.S. government shutdown or former Italian PM Berlusconi’s tax fraud scandal?) but it looks like this theme is here to stay and cause a bigger ruckus in the global markets.

To sum up, here are the foreseen effects in forex:

  • Increased sensitivity of price action to political headlines
  • More volatile moves or prolonged trends in reaction to political developments
  • Increased geopolitical uncertainty, particularly for Western currencies
  • Lack of central bank independence from government
  • Currency intervention concerns back in the spotlight

Care to weigh in on how politics has been driving forex movements these days? Don’t be shy to share your thoughts in our comments section below!