The currencies of the Gulf Cooperation Council (GCC) countries, notably the UAE Dirham (AED) and the Saudi Riyal (SAR), are intrinsically linked to macroeconomic indicators, both regionally and globally. Understanding these dynamics is crucial for effective risk management, especially when dealing with currency pairs involving the U.S. Dollar (USD), Euro (EUR), British Pound (GBP), Chinese Renminbi (RMB), and Indian Rupee (INR).
GCC currencies main characteristicsÂ
A defining characteristic of some of the GCC currencies is their peg to the USD. For instance, the AED is fixed at approximately $3.6725 to $1, a policy that has provided monetary stability and predictability in trade and investment. However, this peg also means that GCC currencies are heavily influenced by the performance of the USD and the monetary policy decisions of the U.S. Federal Reserve. When the USD strengthens, GCC exports become relatively more expensive, potentially impacting trade balances. Conversely, a weaker USD can enhance the competitiveness of GCC exports but may also lead to imported inflation.
Oil is the cornerstone of GCC economies, and fluctuations in oil prices have profound effects on their fiscal health and, by extension, their currencies. Elevated oil prices bolster government revenues, leading to fiscal surpluses and increased foreign reserves, which support the currency peg. In contrast, a sharp decline in oil prices can strain fiscal budgets, potentially causing investors to question the sustainability of the currency peg, thereby increasing market volatility. For example, the historic oil price drop in April 2020 tested the resilience of GCC economies, necessitating adept risk management strategies to navigate the heightened volatility.
Fiscal policy in these countries often involves large investments in infrastructure and social spending, so far funded largely by oil revenues, towards which the GCC leadership is developing and deploying strategy to reduce its dependency but remains a key economic performance factor. When oil prices fall, fiscal policies might tighten, affecting domestic consumption and investment, which can indirectly pressure currency values. In contrast, during oil booms, expansive fiscal policies can lead to currency appreciation due to increased foreign investment and higher domestic demand.
Read more | UAE economic outlook: OPEC reports strong fiscal performance, rising tax revenues
Main factors to consider in GCC currency trading
Despite the stability offered by the USD peg, currency pairs involving GCC currencies and non-USD currencies, such as EUR, GBP, RMB, and INR, can exhibit volatility due to several factors.
- Monetary policy divergence: Differences in interest rates and monetary policies between the U.S. and other economies can lead to fluctuations in these currency pairs. For instance, if the European Central Bank adopts a more accommodative monetary policy compared to the U.S. Federal Reserve, the EUR may weaken against the USD, and by extension, against the AED.
- Geopolitical tensions may lead to sudden shifts in investor sentiment and risk appetite. Such events can cause capital flight to safe-haven currencies, increasing volatility in GCC currency pairs.
- As previously discussed, significant movements in oil prices can impact the economic stability of GCC countries, thereby affecting their currencies. A sudden drop in oil prices can lead to depreciation pressures on GCC currencies, especially against currencies of countries less dependent on oil exports. Other commodities like gold, which GCC countries are diversifying into, can influence currency stability.
- Tariff wars: The new U.S. administration’s policies on tariffs, particularly if they involve major trading partners of the GCC, could introduce an additional layer of uncertainty. Tariffs could disrupt trade flows, impacting currencies through changes in trade balances and investor confidence. A balanced approach to understanding these dynamics would suggest monitoring policy announcements and their implications on global trade routes.
In light of these factors, effective risk management is paramount. As I have previously emphasized, a proactive rather than reactive approach is essential in navigating the complexities of forex markets.
Risk management factors and methodology
- Continuous monitoring: Staying informed about macroeconomic indicators, including oil price trends, fiscal policy changes, and geopolitical developments, is crucial. This enables traders and investors to anticipate potential market movements and adjust their strategies accordingly.
- Diversification: Diversifying investment portfolios can mitigate risks associated with exposure to a single currency or economic sector. By spreading investments across various assets and regions, one can reduce the impact of adverse movements in any single market.
- Leverage management: Prudent use of leverage is essential, especially in volatile markets. Over-leveraging can amplify losses, so it is advisable to use leverage judiciously and in line with one’s risk tolerance.
- Utilizing advanced technologies: Leveraging technologies such as Artificial Intelligence (AI) can enhance risk management practices. AI’s ability to process and analyse vast amounts of data at unprecedented speeds allows for the identification of potential risks and opportunities that may not be immediately apparent through traditional analysis. This technological edge can provide traders with timely insights, enabling more informed decision-making.
A word of caution: be wary of the critical factor of the quality and reliability of the data used for real time analysis and fed to the AI systems. The accuracy and reliability of the output is critically linked to such quality. Furthermore, avoid the temptation to completely rely on those systems, the output of which must be thoroughly checked and critically evaluated.
In conclusion, while the GCC currencies offer unique trading opportunities due to their linkage with oil and relatively stable exchange rate regimes, they also present complex challenges. Traders must navigate through a maze of macroeconomic indicators, geopolitical risks, and now, potential shifts in global trade policies. The key to success in this environment lies in a disciplined, informed, and strategic approach to risk management, ensuring that opportunities are seized while vulnerabilities are minimized.
About Roberto d’Ambrosio
Roberto d’Ambrosio is the CEO of Axiory Global; he has over 25 years of experience in the field of finance, sales, and business management. Roberto began his journey as an independent trader in 1994, and since then, he has served many positions in the world of finance and business successfully. He is skilled in public speaking, presentation, coaching, mentoring and an expert in up-keeping, creating, and analysing investment portfolios. In-depth knowledge of project management, business planning, budget control, risk management, and resource management makes him proficient in the business world. Knowledge, experience, continuous professional growth, and work ethic of Robert helped him in leading different brands and making them successful.
Through tremendous expertise, financial and management skills, Robert earned the position of Chief executive officer in Axiory, and he is taking the company to new heights by strengthening and streaming the operations, product line, and drive growth. His articles on finance, growth, and business management are published on some of the reputed magazines and newspapers. Robert has mentored many students and staff members who are today successfully working in their respective fields.
Mr. Roberto was the co-founder, CEO, and CIO of Araknos Investment Managers and involved in several prestigious roles, including non-executive directorships within regulated financial services firms. Previously, Roberto held senior executive positions in leading brokerage firms like FXDD, Tier1fx, and Alpari. Robert has completed his master’s in business management from Henley business school. He is certified by MITC & RIMAP in risk management, along with that he is MFSA approved senior manager, and FSC Approved Investment Manager.Â
