Economic conditions in recent quarters have been a positive for the financial markets, with growth across key economies have been in sync for some time, supporting positive corporate earnings and the record highs across the global equity markets seen earlier in the year.
In spite of the broader global economic outlook being on the positive side, geopolitical risks have continued to create significant volatility in the global markets. At the time of writing, geopolitical risks being a possible North Korean crisis, an anti-EU coalition government in Italy, the threat of a trade war between the U.S and China, prolonged NAFTA negotiations, the U.S withdrawal from the Iran nuclear agreement and the threat of trade tariffs on European goods imported into the U.S being amongst others.
During periods of heightened geopolitical risks, there are some currencies that are at risk of sizeable losses as the markets having a tendency to reverse risk-on trades that are in search of yield.
Commodity currencies are usually the first to feel the pinch during periods of rising geopolitical risk. The theory being that an extended period of geopolitical risk in a key region or economy would ultimately have an adverse effect on economic growth and therefore demand for raw materials and goods.
The Aussie Dollar, the Canadian Dollar, and the Kiwi Dollar fall into this category. The respective economies highly reliant on favorable trade terms to support positive sentiment towards higher interest rates, causing yield differentials.
For the very reason that yield differentials favor capital flows into the respective currencies from low-interest rate environments, carry trade reversals also hit the respective currencies hard. Risk-off periods seeing investors move money into the safety of the Swiss, the Yen, the USD and even the EUR.
Making the right moves as the news hits the wires is of particular importance and, without the influence of other factors that can offset negative sentiment towards geopolitical risk, going short on the risk-off currencies that include the AUD, CAD and NZD are traditional moves that the broader market makes.
Any kind of war, whether military or trade, will ultimately impact demand, either through a slump in consumption or through supply disruption, both kinds tending to have dire consequences on export-driven economies. The EUR an exception for the sole reason of its evolution into a funding currency in the wake of the Global Financial Crisis.
While prolonged crisis ultimately weighs on demand, it’s also worth considering the impact of a regional conflict that can influence the supply of raw materials to economies that are sheltered from such crisis. For the Canadian Dollar, while geopolitical risk driven trades would traditionally be considered a negative for a commodity currency, crude oil supply disruption due to a conflict in the Middle East, for instance, could be considered a positive. Demand for crude oil in the near-term unlikely to be impacted by militia seizing control of refineries, as an example.
This is the very reason that traders need to be mindful of the near-term, medium-term and longer-term effects of any risk event and whether rising tensions are likely to ultimately escalate into something more event-driven that can lead to a shift in appetite in favor of the safe havens.
Safe Haven Assets
Traditional safe-haven assets tend to be the ‘go to’ trades in moments of crisis, the severity of crisis ultimately dictating the level of demand and therefore the moves that can be anticipated.
Safe haven assets include Gold, Silver, the Japanese Yen, the Swiss Franc, the EUR and Government Bonds.
The Japanese Yen and Gold may have been the long-standing safe havens that find the strongest demand, while the Swiss France is also up there, with traders not only going long Japanese Yen and Swiss Franc against the Dollar, but also against the crosses. For instance, geopolitical risk in the Eurozone seeing the EUR-CHF on the decline as the market moves out of the EUR into the Swiss Franc.
When trading geopolitical events, it is imperative to move quickly on the news, while also forming a longer-term view and keeping up to date on the risk outlook to provide you with a short, medium and longer-term trading strategy to manage the risk in question.
Going long Japanese Yen, Swiss Franc and even gold in response to risk-off news is the way to go, while going short on commodity currencies also provides value, with the exception of the USD/CAD pairing that could be favourable for the Canadian Dollar should geopolitical risk raise the prospects of crude oil supply disruption from the Middle East, as is the case now, with the U.S withdrawing from the Iran nuclear agreement and imposing fresh sanctions.
Trading Geopolitical Events
When looking at the technical analysis, key resistance levels, and FIB Retracement Levels, it’s worth noting that support and resistance levels become particularly strong or particularly week, depending upon the pairing and the event.
To determine the length of a given trade is a little more of a challenge and can vary, though the markets have a tendency to move on as risks ease. In the case of North Korea, the currency markets have become more resilient, leaving monetary policy and sentiment towards trade talks or other geopolitical events to take the center stage. While some geopolitical risks ease quickly, creating the need for scalp trading, some risks cause a longer effect that demands a long-term position.
New geopolitical risks will generally overshadow lingering ones, the only exception being if there is an escalation to a level not experienced by the markets previously.
Taking scalps trades (small quick profits through intraday trading), looking at a swing trade strategy and even a longer-term positioning to profit from rising geopolitical risk are all reasonable strategies and a blend of the 3 would be most suited to manage the geopolitical risk that is ever present in the global financial markets.
It is important to select a platform that provides the appropriate trading tools and access to the full suite of global currencies.
Rakuten Securities is considered to be one of the top three brokers in Japan, the largest Asian FX market, whilst also having brokerages in Australia, Hong Kong, and Malaysia. Rakuten Securities’s strong liquidity and low fees are ideal for traders looking to trade FX directly or through CFDs with the intention to scalp or swing trade or take long-term positions.
This article was originally posted on FX Empire
More From FXEMPIRE:
- Comex High Grade Copper Price Futures (HG) Technical Analysis – May 17, 2018 Forecast
- Grains Rebound as Planting Progress Accelerates
- The Case for a Higher USD/JPY
- Gold Continues to Decline against Firm USD While Crude Hits 3½ Years High
- USDCAD on Bearish Slump Post Negative EIA Data
- 3 Potential Bearish Opportunities