Currency markets are often described as the most efficient pricing mechanism in finance. Trillions of dollars change hands every day, and exchange rates adjust in real time to new information. But when geopolitical events erupt — a military conflict, a trade war, an unexpected election result — even the deepest, most liquid market in the world can be caught off guard.

For the Australian dollar, geopolitical risk is not an abstract concept. It is a force that can move the exchange rate by several cents in a matter of days.

The Mechanics of a Geopolitical Shock

When a geopolitical event hits, currency markets respond through several channels simultaneously.

Risk aversion: Investors pull capital from riskier assets and move it to perceived safe havens. The US dollar, Japanese yen, and Swiss franc are the traditional beneficiaries. The Australian dollar, classified as a risk currency due to its commodity exposure and high-beta characteristics, typically sells off.

Trade disruption: Events that threaten global supply chains or trade flows — sanctions, blockades, tariffs — can reshape the economic outlook for trade-dependent economies like Australia. If a conflict disrupts shipping routes through the South China Sea, for instance, the implications for Australian commodity exports are immediate and material.

Commodity price spikes: Wars in oil-producing regions push energy prices higher. While Australia is a net energy exporter and benefits from higher coal and LNG prices, the broader economic disruption caused by an energy shock can overwhelm this benefit.

Capital flows: Geopolitical uncertainty can redirect foreign investment. If investors perceive Australia as relatively safe and stable, it may attract capital inflows that support the currency. If the event raises questions about Australia’s own security or economic stability, the opposite can occur.

Case Studies That Matter

The conflict in Ukraine, which escalated in 2022, provided a textbook example of geopolitical forces in action. Energy prices surged, risk appetite collapsed, and the US dollar strengthened sharply. The AUD initially fell before recovering on the back of higher commodity prices — illustrating how multiple channels can push in different directions simultaneously.

US-China trade tensions have been a recurring theme for the AUD. When tariffs are imposed or escalated, markets price in lower Chinese growth, reduced demand for Australian commodities, and broader risk aversion. The AUD has been one of the most sensitive G10 currencies to US-China trade headlines, reflecting Australia’s deep economic ties with both nations.

Elections can also move currencies, though typically through the policy uncertainty they create rather than the result itself. The 2024 US presidential election and its implications for trade policy, fiscal spending, and international alliances had a measurable impact on AUD/USD positioning in the months before and after the vote.

The Australian Dollar’s Vulnerability

Australia’s currency is particularly exposed to geopolitical events for several structural reasons.

First, Australia is a commodity exporter. Commodity markets are global and sensitive to supply disruptions, trade barriers, and demand shocks — all of which can be triggered by geopolitical events.

Second, Australia’s largest trading partner is China. Any geopolitical development that affects China’s economy — whether it is a trade dispute with the US, tensions in the Taiwan Strait, or domestic political shifts — feeds directly into AUD pricing.

Third, the AUD is a liquid, freely traded currency that is easy to sell. In moments of panic, traders looking to reduce risk exposure across their portfolios will sell liquid risk currencies first. The AUD, along with the Norwegian krone and the New Zealand dollar, often bears a disproportionate share of the selling pressure in risk-off episodes.

How to Respond

For traders, geopolitical events create both risk and opportunity. The challenge is that these events are inherently unpredictable in their timing, though not always in their consequences. A trader who understands the transmission channels — risk appetite, commodity prices, trade flows — can position more effectively when events unfold.

For businesses, the lesson is simpler: geopolitical risk is a reason to hedge, not a reason to speculate. A company with significant foreign currency exposure that chooses not to hedge because “things seem calm” is taking a bet that calm will continue. History suggests it will not.

Building a hedging programme that accounts for tail risks — low-probability but high-impact events — is more prudent than trying to predict which crisis will emerge next. Forward contracts, options, and portfolio diversification are all tools that can reduce vulnerability to sudden currency moves.

The Bigger Picture

Geopolitical risk is not new. Currency markets have always been shaped by wars, revolutions, sanctions, and political upheaval. What has changed is the speed at which information travels and markets react. A headline can move AUD/USD by 50 pips in seconds. By the time most people have read the news, the market has already moved.

This speed makes preparation more important than reaction. Understanding your exposure, having a plan for adverse scenarios, and maintaining hedging discipline are the foundations of sensible currency risk management in an uncertain world.

The Australian dollar will continue to be moved by events beyond Australia’s borders. That is the reality of being a small, open, commodity-exporting economy in a turbulent global system. The question is not whether the next geopolitical shock will come — it is whether you are ready when it does.