As the largest, busiest and most liquid trading and investment platform in the world, the forex market is sensitive to geopolitical events. Some forex traders prefer to take positions according to technical analysis while others stick with fundamentals, but both will take into account global news headlines, particularly as they apply to the economic and monetary policy.
News about tax cuts and other policy moves that can impact sovereign revenue will certainly have an effect on the forex market, but it is important to understand the context of the reports. When tax cuts are enacted by major economies, there should be an understanding that treasury revenue will decrease, and this could either be interpreted as good or bad news for the economy. Before getting into the details of national revenue, tax cuts and their effect on the forex market, it is crucial to understand how headlines and reports by analysts work.
Global Events: News Vs. Analysis
Looking back at the political events that unfolded on November 8, 2016 has become a case study on how markets react to major global events. On that day, forex markets were mostly quite; traders of major currency pairs that included the United States dollar were anxiously awaiting reports from polling stations as votes were tallied for candidates Hillary Clinton and Donald Trump.
Wall Street had already closed by the time the shocking news of Trump taking an early lead began to emerge; however, after-hours traders began dumping shares. A ripple effect extended to markets overseas, and this was not a reaction to the idea of a Trump election; it was actually the panicked realization that all the forecast and models that predicted a Clinton landslide were wrong. Some traders believed that voting systems may have been compromised, thus creating a sell-off that grew into a trend. In the forex market, the USD began losing pips as the DXY began losing ground.
The vote rigging fears would later subside as analysts correctly attributed the Trump advantage to the quirky Electoral College system of the U.S., which resulted in a Trump victory despite a Clinton edge of more than two million popular votes. Later, market analysts pointed out that the tax cuts and infrastructure projects proposed by the Trump campaign would provide an even greater boost to the American economy, which resulted in a Wall Street rally the following day. As expected, the greenback also recovered and the DXY recovered.
The lessons that forex traders can learn from the American elections is that political instability will invariably rock the markets and send everyone on a flight to safety mission; conversely, technical traders who took EUR/USD buy positions during November 8 cashed in on a few pips. Fundamental traders probably exited their positions and waited for analysis reports.
The Complexity of Tax Cuts and Revenue Estimates
As previously explained, tax cuts often involve a pullback in treasury revenue, which could translate into a lower value for the national currency under some circumstances. Tax cuts are good news when they are first reported because they tend to evoke positive sentiment, and this was certainly the case when the Trump administration was able to score its first major political victory with a tax reform package. It is easy to envision more cash in the pockets of Americans and increased revenue for companies; this could translate into a good technical play based on more valuable USD, but fundamental traders will likely wait for analysis.
Tax cuts may not have an effect on projections of decreased consumer spending, looming unemployment, inflation, and projected bond yields. In the case of American tax reform, the strength of the DXY has been mostly based on the shaky performance of other major currencies, and the effects of the global trade war are still likely have a greater impact in the future.