There are many factors that influence the price movements of financial assets. For example, a hawkish Fed may lead the dollar higher while better-than-expected projections can take a stock higher. Another factor that we regularly talk about is geopolitics. Geopolitics refers to the political issues between two or more countries. In this article, I will look at the role of geopolitics on the financial markets and why traders should care.
A good way to start this is by giving an example. For decades, Iran has been a key country in the Middle East. It has more than 150 billion barrels of crude oil making it one of the wealthiest countries in the region. However, Iran is also an Islamic state with leaders who have supported terrorist organizations such as Hezbollah. It is also one of the countries that has been designated as a state sponsor of terrorism.
A few years ago, the US attacked Iraq after they suspected the then-leader, Sadam Hussein had weapons of mass destruction. To avoid a similar fate, the Iranian regime decided to develop its own nuclear programs, going against the guidelines of the United Nations.
In the last term of Obama administration and a group of other countries created a deal to prevent the Iranian regime from developing these weapons. The Iran deal was a triumph to international diplomacy and one of the best examples of geopolitics at work.
The first way in which geopolitical issues matters to investors is on the prices of commodities. In the above example, the Iran deal meant that the sanctions that were imposed to Iran were removed. As such, the country could now export crude oil to other countries. This led to increased supply which led to lower crude oil prices immediately after the deal was announced.
The second way in which geopolitics matters to investors is on increased risks. A good example of this was North Korea. Last year, when tensions were rising, most people believed that we were headed to a new world war. As such, global risks soared. In response, investors rushed to safe havens like Japanese Yen, gold, and treasuries. In this case, yen was a safe haven because of the foreign assets that Japan has.
Third, geopolitical issues could lead to a slower growth. A good example was during the Greek crisis. In this, the country took huge loans from the European Union and the IMF to fund major projects. When the projects failed to live within the expectations, the country defaulted on its obligations. This led to one of the most important geopolitical tension in the EU. Greece considered exiting the EU in what was known as Grexit. At the end, the country accepted to the EU’s austerity measures. Brexit was another geopolitical event.
As such, traders should always focus on geopolitical issues. Today, we are faced with a major issue where the US is considering putting tariffs on major goods. The implications of all this could mean increased volatility and falling prices of major financial assets.