Major currencies could be more volatile around election time

>> How political events impact major currencies

Euro/dollar and sterling/dollar have been very stable over the past eighteen months with euro/US dollar rarely outside a 1.05-1.10 range and sterling/US dollar mostly confined to the 1.20-1.30 region. This is in spite of the fact that we’ve seen some notable economic and monetary policy divergences. Politics has been quite benign over the same period, but with elections in France, the UK and the US this year it could be politics that sparks currency volatility.

Two of these elections take place this week, with the UK general election on Thursday and the second round of the French legislative elections on Sunday. A foretaste of the French outcome has been signalled by the first-round elections yesterday, in which the far-right National Rally (RN) secured top spot with a third of the vote. The second round (which sees the top two candidates go through, plus any others scoring more than 12.5% of the vote) usually sees tactical alliances between centrist and left-leaning parties to block out RN. But this is harder this time around, as RN support is high and there will be a record number of third candidates.

Steve Barrow, Head of Standard Bank G10 Strategy, said that it is most likely that RN will fall short of a majority, but, even if that’s incorrect, the fact remains that the fear factor of right-leaning parties coming into power in Europe has diminished, largely because they have abandoned their calls to leave the EU. Instead, migration has become the beacon for such parties; a cause that may be less alarming for the euro even if it seems to offer far-right parties the chance to govern, as we’ve seen in the likes of Italy and the Netherlands. In all, while we find it hard to argue that politics in euro zone countries is a positive factor for the euro, we do not see it as a significantly negative factor either.

Political momentum in the UK is moving in the opposite direction; from right to left. Thursday’s election should see a resounding win for the opposition Labour Party. This will also stand in contrast to many other countries in the sense that a big Labour majority will allow it to get on and deliver the policies it wants, as opposed to the rather more fractured state of politics that we’re likely to see in France where policy change could be stymied.

In the US as well, policymaking in certain areas, particularly budget deficit reduction, has been stymied by the impasse often seen between the president and Congress. In Steve Barrow’s view, the strength of the mandate that the Labour Party seems set to win on Thursday should bode well for modest improvement in the pound over time. Traditionally, shifts from right to left in UK politics have been viewed as detrimental to the economy’s performance and that of the pound. But the evidence has not borne this out. Self-induced political crises have been far more likely under the Conservatives, such as the ERM pullout in 1992, Brexit referendum of 2016, or the former PM Liz Truss’s disastrous mini-budget in September 2022.

>> How willl the UK and US elections impact currencies?

Each cost the pound dearly, and Steve Barrow believes that an absence of such turmoil under a Labour government should help secure a better performance for the pound than we have seen under the Conservatives. But whatever happens in the French and UK elections, it is pretty clear that it is the US election that has the greatest chance of inducing significant volatility into euro/US dollar and sterling/US dollar.

If Biden will win the November 5th election and presides over a modest weakening of the US dollar, it looks unsafe after the presidential debate last week. The alternative, a Trump victory, has the potential to lift the US dollar temporarily, but possibly sharply, after the election, much as we saw when he won in 2016.

“While we are reticent to shift our forecasts materially for the dollar at this stage; we prefer instead to see whether the debate and any future Biden mishaps hurt his polling score in the key states. Even if this is not the case, traders and investors should still be forewarned that the US dollar could, at least, become much more volatile around election time with a clear possibility of a sharp, but temporary jump,” said Steve Barrow.