Politics is deeply interconnected with the financial markets. In fact, a lot of market changes happen after decisions are made on the highest levels.
Global geopolitical events have a significant influence on the Forex market. Major political scandals, wars, elections, peace treaties, nuclear bomb tests, and terrorist attacks lead to inevitable consequences on the financial markets.
Such events reflect on currency rates, with the fluctuations putting an end to old trends and setting up of the new long-term ones. The 9/11 terrorist attacks in the United States were followed by unprecedented geopolitical consequences: starting a war in Afghanistan and Iraq, spending a lot more on US war budget, respectively, leading to a higher US fiscal debt.
Political Risks Affecting the Financial Markets
Political risk comes in many forms. Different policy decision shifts might impact trade tariffs, taxes, or labour conditions. Changes in political leadership can cause government instability. Of course, the worst kinds of political risks are bound with wars, riots, and terrorism.
The Other Side of the Medal
Unexpected policy shifts can influence in a malicious way a company’s ability to follow the strategy and deliver services or products, which ultimately affects the company‘s performance.
But the effects can be not only negative but positive as well. For instance, a company might be fortunate enough to gain unexpected earnings if a certain country’s tax structure is amended, thus affecting minimum wage or regulatory requirements that raise costs. That is if the company in question is able to pass those higher costs on to consumers, of course.
Different Risk Scenarios
Another example is a potential shift in trade laws for a particular industry – like the liberalisation of trade restrictions on the export of US oil and gas. It could result in potential opportunities to trade freely with overseas business partners.
Pretty much the political risk impacts trade at an interstate level. It might stop foreign investors from investing in the debt and equity securities offered by regional companies or government entities. But, on the other hand, it might open brand new markets, so it’s never simply a black-and-white situation.
In terms of equity markets, the political risk could cause a significant decline in the share price of a company. For example, if the government suddenly decides to change the privatisation laws of a particular industry, that could affect in a severe way all the companies in the sector.
Bigger political instability or shifts caused by radical changes of government – could lead to concern among investors and be followed by a decline in the broader market.
How Did the US Battle for Presidency Affect the Markets?
On January 20, 2021, Joe Biden was inaugurated as the 46th president of the United States. But political and financial analysts tried to predict the different scenarios affecting the equity market long before either of the candidates had been elected.
The Trump Scenario
If Donald Trump had been hypothetically re-elected, he would have most likely continued to pursue his Make America Great Again campaign policy. This means sticking to isolationism and severe trade and economic confrontation with China, alongside complex and difficult market relations with the EU. Trump would have probably made an effort to go for more balanced relations with Russia, Japan, and the rest of the Far East.
The healthcare sector was expected to have increased volatility, and the same applied to the energy sector due to the difference between the regulatory stances of the two parties on energy production in the US.
The Biden Scenario
The EU is counting on Joe Biden as a way to obtain more balanced relations with Europe in the long run.
Clean energy, infrastructure, and healthcare services companies are expected to prosper. But the top five best-performing stocks – Facebook, Amazon, Apple, Netflix, and Google (Alphabet), could dip due to Biden’s proposed tax agenda. Pharmaceutical companies would also be affected if he reinforces the Affordable Care Act, because the federal government will have the authority to negotiate lower prescription drug prices that way.
The Bottom Line
Political events, among many other factors that potentially affect market performance, are probably the most difficult to predict. However, they have a significant impact on investment decisions. Nobody likes political instability, and financial markets do not make an exception. But if you analyze further, you might find unanticipated opportunities or at least avoidable risks.