Event risk is generally the risk imposed on the forex market by the external factors. These factors are hard to predict. Some of the most common examples of event risk include wars, terrorist attacks, natural disasters, and rift between countries.
Event risks can affect the financial markets significantly and the traders should not avoid them if they want to progress further. Depending on their severity, the event risks arising in one part of the world can easily spill over other markets and parts of the world. Let’s discuss how the event risk impacts your trading.
Event Risk and Forex Market
Not all events are event risk. Being a forex trader, your first step is to see if an event in gaining enough strength to become an Event Risk. There are two common indicators that can help you know if an event will become an event risk. The first one is Volatility Index, also known as the Fear Index and the other one is the Ted Spread.
When the Forex Market feels threatened by the event risk, the difference of the interbank lending rate and the government interest rate increases drastically. This happens because of the uncertainty that surrounds the Forex market. The central banks are concerned about the value of their own currency and they take every step possible to maintain it. Higher interest rates tend to slow the supply of liquidity, which as a result pushes the currency prices downward and the money needs to be invested decreases.
Real-Life Example of Event Risk
Not long ago, in October 2019, the USD/JPY suffered an event risk when the pair fall back under the 108.72 level. That fall resulted in the risk of the currency falling further. However, the support came from the rising trend after the lows. During this event, the US rate was expected to be cut by a mere 0.25%. The small change in the interest rate was done to keep the fundamentals intact and do not give an impression to the traders that the value of the currency is about to fall drastically.
The event risk can impact different markets and Forex market is not an exception. Usually, the event risks create market stress and cause a Risk Off environment where the fund managers become averse to the risks. In this condition, the traders let go of their risky currencies to prevent future losses. When the currencies are losing value and lack of trust, the government bonds start gaining trust of the investors.
It should be noted here that the USD being the major currency does not get affected by the event risk. This is because that this currency is the major funding currency for most of the world’s investments. When the security of the currency is threatened by an event risk, the risk averse corporations and institutes who have previously borrowed in US dollars make their investments, generally sell their assets and convert the cash back to US dollars. This helps in keeping the value of USD intact.