How Geopolitical Events Influence Financial Market Volatility

Financial markets can often be volatile, which sometimes results in economic instability. This volatility is primarily driven by various political events.

By Andrew Moran

Edited by Joel Taylor

Published November 16, 2023.

a map of the world with chess pieces on it

Volatility is a crucial factor in financial markets. If stocks only marched in an upward direction with no risks involved, everyone would be jumping on the bandwagon to make a quick fortune. But, as we all know, that's not how it goes. 
Unfortunately, volatility can spell trouble for investors and the wider economy, leading to wealth fluctuations and economic dips. So, what's behind this risk in the stock market? Well, one of the big contributors is geopolitical events.
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What Is a Geopolitical Event?A geopolitical event is a significant incident where geography and politics intersect, potentially affecting the economy, financial markets, regional stability, global trade routes, and supply chains.
These events come in various forms, from regime changes to political unrest and military conflicts. They can also lead to trade disputes, sanctions, and uncertainty, impacting not just the entire stock market but also specific financial markets like commodities and foreign exchange.
ExampleRussia's invasion of Ukraine had a profound impact on global energy and agricultural markets, causing significant spikes in the prices of crude oil, natural gas, and wheat. While the stock markets remained relatively stable, the commodities markets experienced ongoing volatility.  Another example is the 2018 trade war between China and the U.S., which created substantial uncertainty, speculation, and fluctuations in stock prices due to tariff announcements, negotiations, and potential resolutions.
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How Do World Events Affect the Stock Market? 1. Trader Sentiment Geopolitical events can affect trader sentiment and alter risk perception. Whether armed conflicts or political stability, the bout of uncertainty can lead to fear among investors, resulting in a sharp selloff in stocks. At the same time, positive developments and peace agreements can bolster investor confidence and lead to potential upswings.
2. Economic ImplicationsGeopolitical turmoil can oftentimes shift to widespread economic implications that can have negative consequences for industries and businesses. So, if a major economy were to impose tariffs on another substantial economy, this would inevitably increase production costs and disrupt supply chains. Then, once the corporate quarterly reports are released, earnings and growth prospects take steep hits—depending on the company, it can lead to market reactions and stock price fluctuations.
3. UncertaintyIf there is one thing investors detest, it is uncertainty. It makes forecasting more difficult, business conditions can be challenging to anticipate, and traders are less inclined to execute investment decisions. Then, of course, the market reaction is mostly negative, and investors will primarily wait for every little development, from speeches to policy announcements.
4. Financial StabilityGeopolitical tensions can threaten financial stability by prompting governments to impose financial restrictions, limit cross-border credit, trade, and investment, and trigger capital outflows. Additionally, higher interest rates on government bonds can increase funding costs.
When Great Britain decided to leave the European Union (EU), it sparked significant volatility and uncertainty in global financial markets. European indexes were particularly affected due to concerns about economic consequences, trade disputes, and regulatory changes. While subsequent events like the coronavirus pandemic and conflicts in Eastern Europe have arisen, Brexit highlighted the substantial influence of geopolitical events on stock market volatility.
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Harnessing Geopolitical Events Trading based on geopolitical events can offer both trading possibilities and challenges for short-term investors who engage in event trading. Some traders prefer geopolitical turmoil, such as those involved in commodities, while others find it frustrating and may reverse their investment decisions.
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