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Lesson 4: Influence of Politics

History shows that many of the sharpest
changes in financial markets have been triggered by political rather than
economic events. For example, high volatility and numerous trading
opportunities were created by the Rapkay vote and the US election.

There is a direct link between politics and
the economy, so it’s no surprise that politics can have a significant impact on
financial markets. But how is this going to happen and why? Let’s find out
about it.

Uncertainty
Equals Volatility

Elections-a common event for most
countries-may have a significant impact on financial markets. Traders can be
seen as an isolated case of potential political instability and uncertainty,
which can lead to greater volatility on both the stock exchange and the forex
market.

Let’s examine how the market acted ahead of
the US elections in November 2016. The consensus was that Hillary Clinton would
be the next president of the United States of America. The vast majority of
credible polling gave Clinton the lead over Donald Trump, so the market was
relatively calm as Trump was seen as the most’ unpredictable’ nominee.
Nevertheless, his election was a big surprise, and that led to some dramatic
changes, as investors had to pay the price for what his presidency would
entail.

Because the vast majority of conventionally
trusted surveys lead Clinton, the markets did not seem ready for Trump’s
victory. A similar situation occurred in the UK referendum on EU membership,
where a largely unexpected’ Leave’ vote caused a sharp drop in the British
pound and led to speculation that the European Union could disintegrate. Such
two events illustrate the apparent global rejection of the existing status quo
and call into question the accuracy of the survey and calculation. Uncertainty,
skepticism and doubt can contribute to more rapid market movements.

Change
– Not Always Welcome

Change in government also means a change in
strategy, which could mean a different approach to monetary and fiscal policy,
both of which, particularly the latter, can be a major driver for financial
markets. The dollar rose after Trump won the election, as the market expected a
looser fiscal policy to pressure the Federal Reserve to raise interest rates.

Generally speaking, most assume that the
more the government spends, the more the economy grows, which could lead to an
increase in inflation. In such a scenario, the central bank of the country
could decide to act by raising interest rates that could support the currency.
In addition, some believe that political parties or individuals that are seen
to be more fiscally responsible or more concerned with fostering economic
growth can improve both the stock market and the currency. Therefore, in the
event that a government that is seen as an economy-friendly is in danger of
losing its position of power, investors may respond nervously and may sell the
currency or stocks.

The
Search for Stability

Stability is something that financial
markets esteem. As we have already discussed, volatility is something that can
have a negative impact on the stock market or the currency. However, when it
comes to politics, it’s not always connected to a change of government. Let’s
remember what happened in 2012 when the eurozone was on the verge of collapse.
Greece almost ran out of money, and politicians could not find a clear
solution. A similar scenario happened in 2015, when the nation was within the
whisker of exiting the eurozone, resulting in some dramatic changes in markets
such as the DAX, CAC40, and many more.

It wasn’t until a political deal was
reached in Brussels that the economy was fully balanced. Although the measures
put in place were far from ideal, the sense of stability caused a significant
rally.

As you can see, economics could have a
major impact on the financial market. That’s why it’s good to follow the
political scene closely.