Geopolitical events should be taken into account by global investors as they can lead to uncertainty and volatility in financial markets.
Caldara and Iacoviello recently revealed in their study that spikes in geopolitical risk indices correlate to drops in economic activity and stock market returns; though their effects eventually diminish with time.
Economic Sanctions
Now that trade has become a global marketplace, sanctions can cause greater economic damage than ever before. A comprehensive trade embargo would lead to significant wage losses for workers in countries supplying Russia or Ukraine; any gains could be partially countered through demand shifts, rerouting exports or tax evasion.
Literature suggests that sanctions have an extremely detrimental impact on economic growth in a target country, with this impact amplified by their scope and duration. Furthermore, sanctions may have unintended side effects such as strengthening authoritarian or statist societies through creating scarcity and decreasing incentive for reform.
Therefore, policymakers must exercise more care when employing foreign policy tools. They should set attainable goals and devise sanctions with multilateral support to enhance their effectiveness; and only use them if the costs outweigh expected benefits.
Political Turmoil
Politico-military instability caused by riots, coups, war, or other events can create global market instability through sharemarket performance of directly affected countries as well as investor trust issues. Currency depreciation could occur and supply chains could become disrupted as a result.
An increase in political risk could shock investors and cause them to sell off stocks as uncertainty and volatility increase, but positive developments and peace agreements can bolster investor sentiment and potentially result in upswings in stock prices.
This year’s events have seen several major geopolitical risks spike, such as Russia-Ukraine conflict, China-U.S. trade war and Hong Kong protests. But even with these risks on the rise, they still remain lower than historical averages; this may be attributed to factors like gradual increases in inequality over time and greater access to information through mobile phones.
Trade Deals
Political events, like trade disputes, can have a dramatic effect on market volatility and investors and policymakers seek to understand their impact and anticipate their occurrence in order to manage them effectively.
Events often have unpredictable outcomes and their impacts can be hard to measure in financial assets. Event studies may help, but their usefulness often depends on the frequency and timing of relevant events.
Geopolitical events have the ability to have a direct effect on consumer and business confidence that has a ripple effect that drives spending and investment decisions, while altering import/export ratios or supply chain dynamics, ultimately increasing global inflationary pressures.
Market Volatility
Trade with other countries brings many benefits; however, global instability wreaks havoc with local economies. From natural disasters that disrupt commodity production or war-induced supply shocks to events like COVID-19 pandemic and trade war between China and Russia which cause supply shocks; events such as these can directly undermine consumer and business trust that flows through to spending and investing; while also amplifying commodity prices due to supply disruption.
Market indices tend to respond quickly and strongly to political developments, with initial reactions usually being stronger for negative events than positive ones. Economic indicators play a vital role in shaping market reactions as positive signals boost investor trust leading to favorable responses in the stock exchanges.