How Political Events Can Shift Your Trading Strategy

If you are setting out as a trader and using trading funds to get started on a one-step basis, you may have a fairly simple, quite cautious approach in mind.

That would make sense, as you will feel you need to find your feet and prove your competence and reliability before seeking to leverage further funding, all the while building up your own capital and experience. The early days may not be the best time for an expansive strategy, still less so a high-risk one.

However, at any time you may be prompted to change your strategy when world events mean that new opportunities arise, or when the approach you were taking up to that point becomes less effective.

A good example of this might be seen in economic developments. For example, the value of one currency relative to others is affected by interest rates, so when there is a change made by any central bank that can bring new advantages or disadvantages for you.

Should it be a pronounced change in policy, such as the 14 rate rises that have seen the UK base rate rise from less than one per cent to 5.25 per cent, that will necessitate a significant re-evaluation, although in the current circumstances, it is worth noting that many other central banks have also raised rates (the exception, as usual, being in low-inflation Japan).

In most countries, these decisions are taken by independent central bankers, rather than politicians, a situation that has been the case in the UK since 1997.

However, rate decisions and other moves by central banks do not exist completely outside political events, either those where a government can make deliberate changes in economic policy or global events beyond the control of a single jurisdiction.

The latter might include events like wars, such as the Russian invasion of Ukraine with its impact on energy prices and the knock-on effect on inflation, which in turn has prompted a tightening of monetary policy. But domestic decision-making is still very important.

This month (November) brings one such example, with the UK government’s autumn statement.

Many years ago, the Budget in the spring would set out taxation and borrowing, while the autumn statement would reveal how money was spent. Now, the latter is effectively a mini-Budget and prime minister Rishi Sunak has hinted there will be at least one tax cut, aided by the fact that falling inflation means this won’t put too much extra money into the economy.

With an event like this with direct economic ramifications, there will inevitably be a market reaction, both on the general financial markets and also on the Forex markets. This can be mild and muted or strong, depending on the detail and the extent to which any new policy announcements will be expected to have a wider economic impact.

A dramatic example of this occurred last year when, just after Liz Truss began her brief and ill-fated stint as prime minister, her chancellor Kwasi Kwarteng delivered his mini-Budget with a raft of radical announcements, not least sweeping tax cuts.

The reaction of the markets was very negative amid concerns that the public finances would soon be out of control, leading to the value of the pound plummeting to its lowest level against the US Dollar in nearly 40 years. For any Forex traders who had been banking on Sterling being relatively strong, a rapid change in strategy was required.

Part of the turmoil in a situation like that can come from the great uncertainty and volatility that arises. Very quickly after the mini-Budget it seemed clear that the whole plan was starting to unravel and attempts by Liz Truss to overcome what she had called “Treasury orthodoxy” were foundering on the rock of market reality.

The consequence of this was that Mr Kwarteng was sacrificed by Ms Truss in a desperate attempt to rescue her premiership, one which failed and saw her spend a record short time in office.

Subsequently, the arrival of Jeremy Hunt as Chancellor and former chancellor Rishi Sunak as prime minister signalled a return to more normal policies – thus altering trading strategies yet again as Sterling gradually stabilised.

The sort of political turbulence in which the UK can have three different prime ministers in less than two months was unprecedented, although it is far from the only dramatic political event to impact markets.

While an economic crisis like that of 2008, the Covid-19 pandemic or war in Ukraine is external, internal events like the 2014 referendum on Scottish independence (with some polls running neck-and-neck with a week to go), the 2016 Brexit referendum and its consequences, and general elections can all have an impact.

Some of these situations can be impacted by speculation (caused by the uncertainty of an upcoming vote that promises to be close), while others are determined by the outcome; the Scottish verdict in 2014 maintained the status quo, whereas Brexit demolished it and produced great volatility.

While no referendums are coming up soon (much as advocates of Scottish independence would wish otherwise), we can expect a general election in 2024, although technically it can be held as late as early 2025.

As the opinion polls have been indicating a large lead for the Labour Party, this is one event that is open to less speculation, as the outcome of a change of government with a large majority looks overwhelmingly likely.

This would represent uncommon levels of stability at a time of change, as it would be only the second time since 1945 that a single-party government with a clear working majority had been replaced by another, the last such instance being in 1970.

Nor would a change of government be likely to bring any radical shift of economic policy, unlike the prospects under Jeremy Corbyn’s leadership. The only uncertainties seem to be the timing of the election and the finer details of manifestos.

Nonetheless, there will be some market reaction and there is always the possibility of some policy surprises, some of which may not even be in the manifesto (Labour gave no prior hint of giving the Bank of England interest rate independence before coming to power in 1997).

It is not just the UK that has an election coming up either. The date of the US Presidential election is, of course, written in stone as November 5th, a day when there may be even more fireworks across the Atlantic than in Britain.

Since so many currency transactions involve the US dollar, matters of speculation, policy, uncertainty (if the polls are tight) and unexpected twists in the campaign may all be relevant, as might any post-election volatility if the result is disputed again.

Similarly, currency values may be impacted by the electoral cycle too. In some cases this is not just about the elections themselves but how governments prepare for them; the tax cuts promised by Mr Sunak are typical of the kind of giveaways sitting administrations like to dish out to voters before seeking re-election.

In some cases, you might want to consider whether such events mean you might even stop trading in particular currencies altogether because of a volatile situation. Indeed, the Truss-Kwarteng fiscal experiment may be an exemplar of the kind of circumstances in which it is best to sell your stock of one currency to limit losses and try to make it up with others.

There may be some currencies you decide to avoid in the first place because of the potential for volatility, but if you do take a punt on them now, there may be strong reasons to change course.

For instance, there are probably not many people based in the UK who trade in the Argentine Peso, but anyone doing so might be spooked by pledges by the incoming president Javier Milei to cut trading ties with Brazil and China (its biggest economic partners) and dollarise the economy.

All that might make events like Brexit and the Truss-Kwarteng mini-budgets seem like mild measures, but it also shows that whatever your initial trading strategy, one of the best reasons for modification can be a significant change in economic circumstances as the result of specific policy decisions.

It remains to be seen how the markets react to the UK’s autumn statement, the Budget in the spring and then the first signs of a result (such as the exit poll) in the general election. In the latter case, the signs of a clear result would be most settling for markets, as they can plan with more certainty. The key is to look out for shocks that will ‘spook’ the markets.

If you are just starting out as a trader, it may be wise to begin formulating your strategy by avoiding too many trades in your spread that are focused on the currencies of countries either generally prone to unstable economic or political circumstances, or at a specific point of great uncertainty (such as an upcoming knife-edge election).

As your approach develops, you may then find that in most cases, a more settled and certain situation has a clear and predictable impact on the relative value of a currency that enables you to set up trades to capitalise on this, always being mindful of the economic and political situation of the economy providing the other currency.

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