How political events impact major currencies

>> Currency market calm could be shattered by the US election

If this year is the year of the election, then things are about to heat up. After major elections in a number of emerging market countries, such as India and South Africa, the focus is turning to the developed world. The first round of French parliamentary elections occurs on Sunday and, next Thursday, the UK goes to the polls to elect a new government. Before all that, US presidential combatants Biden and Trump face off in the first of their televised debates early on Friday morning. The US election still looks as if it will prove the most likely to generate currency volatility.

Steve Barrow, Head of Standard Bank G10 Strategy, said that incumbent Biden would win a second term. Opinion polls, while seemingly showing an improvement for Biden only show the two candidates’ roughly neck and neck if you average across national and state polls. This tends to suggest that it will be impossible to confidently call the outcome of the election before the November 5th polling date, and this, in turn, suggests to us that there will be minimal pre-election movement in the US dollar but potentially huge post-election volatility, especially if former President Trump takes the spoils and is backed by a Republican majority in Congress.

Such an outcome would presumably lift the US dollar, at least temporarily. If, just ahead of election day, euro/dollar is still in a 1.05-1.10 range, then Steve Barrow expects a Trump victory to push the euro down to the sub-parity region but, just like his victory in the 2016 election, a Trump bump for the US dollar lasts little more than a few months. In contrast, a victory for Biden may simply serve to solidify the 1.05-1.10 range even more, with perhaps a more likely drift higher for the euro and lower for the US dollar as traders and investors anticipate lower rates from the Fed.

Political uncertainty is matched by France as the first round of parliamentary elections takes place on Sunday with the second a week later. Polls suggest that the far-right National Rally (RN) will become the biggest party with the left-wing New Popular Front (NPF) alliance second and President Macron’s centrist alliance further back in third.

A majority for the RN seems unlikely, but such is the uncertain nature of this snap election that it can’t be ruled out. Financial markets have certainly taken fright; particularly the French bond market while the euro has eased down and shorter-dated (1-month) risk reversals for euro/dollar have seen their steepest moves towards a higher price for euro puts than big events in the past such as the Russian invasion of Ukraine and COVID.

>> What if Donald Trump wins again?

The two key political issues are, firstly, whether RN can win a majority and so agitate the balance within the euro zone further to the right. The second is whether a lack of a majority for RN could create a period of political instability in which forming any government proves difficult, if not impossible. Either could, in theory weigh on the euro.

However, the sense of the drift in euro zone politics we have seen for many years now is that euroscepticism among many right wing parties in the likes of France and Italy has largely been replaced by anti-immigration sentiment. That’s something that is not surprising given it seems that policies such as EMU withdrawal won’t win far-right parties sufficient support to gain power. Anti-immigration, in contrast, seems to draw wider support.

That’s of importance for the euro as the currency looks vulnerable on an anti-EMU platform but not necessarily on an anti-immigration agenda as arguably, we’ve already seen in Italy. So, while the French election could put some pressure on euro/dollar, pushing it to, or even slightly below, the 1.05 level that has marked the bottom of the trading range for some time, we are not generally becoming concerned about significant damage to the single currency.

“This just leaves the UK election on July 4th which is the only one that’s easy to call. A solid Labour win is likely to result from a split in the anti-immigration vote between the Conservatives and the Reform Party. The prospect of a stable government here could mean that the pound gains the upper hand from this triple dose of political uncertainty”, said Steve Barrow.