How Does Civil Unrest Impact The Forex?

Over the course of human history, certain periods of time have proven especially tumultuous. Racial divides, famine, pandemic and political upheaval all pose unique challenges. In some cases, these events stimulate extreme social conflict. From the late-18th century French Revolution to the end of South African aparthied 200 years later, civil unrest has been a disrupter of financial markets, economic systems and the global currency exchange.

Although the forex is the world's largest market, featuring more than US$6 trillion in daily turnover^[1], it isn't immune to the pressures brought on by a societal breakdown. No matter if one is trading euros, U.S. dollars, or Lebanese pounds, the condition of a nation's populace is a key driver of stability and strength to its domestic currency.

Traders And Investors Aren't Fond Of Uncertainty

Traditionally, financial markets do not favour uncertainty. The forex is no different, as questions regarding politics, economic development and social harmony are capable of impacting exchange rates dramatically.

Although not a conventional market driver, civil unrest can have a profound impact on the valuations of forex currency pairs as well as other asset classes. This is due to added uncertainty regarding economic growth, commodity pricing and changes to monetary policy.

Economic Growth

According to the United States Federal Reserve Bank of St. Louis (FRED), economic growth relies on three factors: more capital, more labour and greater efficiency in the use of existing capital and labour.^[2] In addition, FRED states that three types of institutions are vital to sustaining economic growth^[2].

1. Judiciary

A functional, strong legal system is required to enforce the rule of law and protect property rights. Citizens that feel secure about their property being protected are more likely to work hard and reinvest into the domestic economy.

2. Competitive Markets

Free, open markets encourage competition, which promotes innovation, efficiency and economic development.

3. Financial Institutions

Banks, credit unions and stock markets facilitate the flow of capital from savers to borrowers. This is an essential part of providing the financial resources necessary for economic expansion.

At their core, protests and riots are events that express a conflict with the status-quo. Accordingly, the goal of many such activities is to fundamentally change the role that institutions play in society itself; or, in some cases, abolish the institution altogether. If such efforts are successful, the shifting dynamic and ensuing adjustment period can bring significant forex tumult.

Pots And Pans Revolution

One prominent example of civil unrest impacting a country's institutional structure was Iceland's "Pots and Pans Revolution." Amid the Global Financial Crisis of 2008, thousands of Icelandic residents held weekly protests in condemnation of sudden indebtedness and economic downturn. The eventual result was the indictment and jailing of several prominent Icelandic bankers^[3], including charges of negligence filed against Prime Minister Geri H. Haarde.

The largest protests of the Pots and Pans Revolution occurred during January 2009 as participants pressed for sweeping government resignations. During that period, the Icelandic krona (ISK) gyrated wildly as currency traders evaluated the social discourse. For January 2009, the USD/ISK fell from 121.42 on 1 January 2009 to 114.94 on 31 January 2009.^[4] The move represented a gain of more than 5% for the krona as optimism over an end to Iceland's economic strife dominated market sentiment.

Commodity Pricing

During periods of civil unrest and active revolution, commodity prices can be greatly impacted. Crude oil, gold, diamonds, coffee and wheat are a few examples of raw goods that have historically expressed a sensitivity to social conflict. In many cases, the production of these materials depends upon labour pools local to developing nations. When there is a disruption due to large-scale protests or worker strikes, the result is market turbulence.

Commodity prices have a multitude of drivers, unique to each raw material. However, values fundamentally depend on the relationship of supply to demand. While civil unrest does little to hamper demand in the short-run, the immediate impact on available supplies can be profound.

For example, during the Arab Spring uprisings of 2011, the production of crude oil in the Middle East and North Africa regions (MENA) plunged. A benchmark of global output, MENA nations accounted for 35% of the world's production, measuring 29 million barrels per day.^[5] As the Arab Spring revolutions unfolded throughout early-2011, MENA nations found it impossible to sustain output given the evolving security concerns. One of the hardest hit countries was Libya, which solely accounted for a 1.5 million barrel per day loss in output.^[6]

Aside from leaders in Libya, Tunisia and Egypt entering exile or being killed, the biggest impact of Arab spring was a spike in crude oil prices. During spring 2011, West Texas Intermediate (WTI) and North Sea Brent (BRENT) crude oil futures sustained trade above the US$100 threshold.^[6] For the year, WTI and BRENT averaged multi-decade highs, coming in at US$94.87 and US$111.26, respectively.^[6]

On the forex, crude oil-sensitive commodity dollars posted significant gains against global majors. Among the most prominent was the Canadian dollar (CAD), which put in a strong four months against the USD:

• In February 2011, the USD/CAD lost -2.97% for the month.
• For March 2011, the USD/CAD traded flat, closing down -0.10%.
• Losses for the USD/CAD resumed in April 2011, with the pair losing -2.52%.
• As global crude oil pulled back from yearly highs in May 2011, the USD/CAD rallied by 2.35%.

Simply put, the violent revolutions of Arab Spring spiked the price of crude oil, which in turn boosted oil-related currencies. Subsequently, traders and investors sought gains in the commodity dollars as the societal angst negatively influenced oil production.

Monetary Policy

In reality, civil unrest is a product of various individual or contributing factors. Issues such as food scarcity, commodity prices, racial tensions and inflation are common to periods of societal angst.^[7] Aside from governments, the key institution commissioned with promoting harmony is the nation's central banking authority.

The primary function and purpose of a central bank is to foster sustainable economic growth and prosperity for the domestic population. To accomplish this goal, monetary policies are instituted designed to advance pricing stability. This concept is reinforced by the official mission statement of the European Central Bank (ECB):

"The ECB and the national central banks together constitute the Eurosystem, the central banking system of the euro area. The main objective of the Eurosystem is to maintain price stability: safeguarding the value of the euro."^[8]

The tools that central banks use to deliver sustainable growth, maximum employment and pricing stability are known as monetary policy. Among these devices are adjustments to interbank interest rates, direct lending and debt purchase facilities.

U.S. Fed's Reaction To COVID-19

As an illustration, the United States Federal Reserve (Fed) dramatically shifted policy to address the coronavirus (COVID-19) pandemic of 2020. Near-zero interest rates were enacted nearly overnight as part of a massive lending/debt-purchasing program known as unlimited quantitative easing (QE).^[9] In adopting these measures, the Fed hoped to restore economic growth as quickly as possible following the global COVID-19 economic shutdown.

In the wake of COVID-19, the Fed took preemptive action to reduce the chances of civil unrest related to the pandemic. Unlimited QE aimed to provide emergency liquidity to the financial system, ensuring that as many businesses as possible remained solvent and workers employed. In response to the swift increase in the money supply, the USD experienced severe bearish volatility. From 1 March 2020 to 1 September 2020, the greenback struggled to find solid ground on the forex:

• EUR/USD: Rates of the EUR/USD rallied by 891 pips (+8.1%)
• GBP/USD: The GBP/USD spiked by 586 pips (+4.5%)
• USD/CHF: For the USD/CHF, values fell by 591 pips (+6.1%).
• USD/CAD: Values of the USD/CAD lagged by 387 pips (-2.8%).
• USD/JPY: As a safe-haven currency pair, the USD/JPY fell by 149 pips (1.3%).
• AUD/USD: The Aussie gained 911 pips (14.1%) in relation to strong gold pricing.
• USD/NZD: USD/NZD rates trended south, losing 1156 pips (7.2%).

Albeit indirectly, civil unrest does play into the psyche of central bankers when crafting policy. For crises like COVID-19, policies are adopted to cushion the economic damage and preserve the societal structure. Nonetheless, there are instances where populations have protested in condemnation of central bank policies.

Protest Of Lebanese Central Bank

On 6 June 2020, demonstrators in Lebanon attempted to take over the nation's central bank, Banque du Liban, in response to fading currency values. Following a 50% crash of the Lebanese pound (LBP) vs the U.S. dollar^[10], riots broke out in Beirut in protest of failed central bank policies. The unrest lasted for more than 100 days and forced the sitting government to resign.^[11] As a result, the LBP experienced a period of extreme volatility.

Summary

Although civil unrest is not a conventional forex market driver, it is capable of acutely impacting a currency's value. Periods of riots, looting and violence typically spike volatility and undermine the afflicted nation's monetary system. Due to its negative influence, central banking authorities work to craft policy designed to foster pricing stability and sustainable economic growth.

For active forex traders, it is important to remain cognisant of developing social pressures. Historically, leading indicators of such events are extreme commodity pricing volatility, political upheaval and consequential shifts in central banking policy. In cases where one or more of these factors is present, civil unrest may evolve into a key underpinning of the forex trade.