Bracing for Election Year Uncertainty
A tumultuous 2019 has given way to another year that seems likely to be replete with geopolitical uncertainties. One event that is bound to have an outsized impact on currency markets is the U.S. presidential election. Companies with foreign currency exposures should ensure they understand the potential repercussions of various possible outcomes and anticipate them within their risk management policies.
2019 in Review
On a net basis, the U.S. dollar was virtually unchanged last year, whether measured against other major currencies or emerging market (EM) currencies. This does not mean that it was stable against individual currencies, however. As the chart illustrates, most of the significant moves were against EM currencies; among major currencies only the Canadian dollar and the Swedish krona shifted more than 5%.
Last year provided a useful reminder that weak currencies usually remain weak unless their underlying problems are addressed. For example, the Argentine peso, Angolan kwanza and Turkish lira were the three weakest currencies in 2018. The peso and the kwanza maintained the same ranking in 2019, while the lira was the tenth weakest currency. The reverse is not usually true. It is uncommon for currencies to continue to enjoy large appreciations year after year as governments and/or monetary authorities usually take offsetting policy actions to help limit the negative impact of appreciation on competitiveness and exports. For instance, Thailand has taken steps recently to spur capital outflows (though the impact has been dwarfed by the concerns over the coronavirus, which originated in Wuhan). Israel and Ukraine have also been debating how to counter the strength of their respective currencies.
2020: Elections Loom
2020 could be a significant year for foreign exchange markets, and the U.S. elections may have an outsized influence on how the dollar performs. According to Calvin Tse, Citi’s senior G10 FX analyst, the dollar has on average appreciated against other major currencies during election years. However, this average is upwardly biased due to major outperformance during the elections and re-elections of Presidents Reagan and Clinton.
The important takeaway for corporates with foreign currency exposures is that there is major uncertainty about the election outcome, and consequently in the potential impact on currency markets. The current trend of a strong dollar is likely to remain intact if Republicans win the presidency. If this occurs, US companies with foreign currency-denominated revenues may be negatively impacted, while those with foreign currency expenses may experience slight windfalls as costs will be lower in dollar terms.
If a Democrat is elected, there may be more uncertainty and a possible bias towards a weaker dollar (though the extent depends on the nominee). As Tse notes, any Democratic nominee has the potential to be somewhat USD negative, since all could roll back business-friendly initiatives that Republicans have put in place during the current administration (most notably, tax cuts). However, the more severe tail risk lies with left-leaning candidates who have announced agendas that include increased regulation and taxation.
The key point is that corporates will need to pay close attention to their hedging programs in order to effectively manage uncertainty in the event of either a Republican or Democratic victory. The effects on companies will be specific to the nature of their foreign currency exposures – i.e. whether they have FX expenses or revenues. Appropriate hedging strategies can go a long way towards managing the effects of unwanted volatility on operating or financial results in the coming year.