How do elections affect the value of currencies and why is this important for people living abroad?

Elections and referendums have the ability to cause major shifts in geopolitical and economic factors across the world. We saw in 2016, with the Brexit referendum, an unprecedented shift in the value of GBP against all major currencies, and impact which has not yet returned to the pre-referendum values.

On the night of the vote, even misplaced comments were enough to cause shockwaves in the value of GBP over the course of the minutes and hours before the final result was announced.

Of course, there have also been other major political events which have caused seismic shifts over the years, whether the outbreak of war, announcements of major spending changes and regulatory changes.

As both the UK and US general elections loom, along with European elections, 2024 promises to offer political turbulence and surprises.

What impact might these events have on foreign exchange rates and how will this affect people with financial affairs spanning multiple countries as well as expats needing to move large amounts of money in the coming weeks and months?

We spoke with one of our expert partners, David Huggett of Lucid Financial Markets to understand what expats need to know about currency fluctuations, how the upcoming elections might impact currencies and why expats should engage a foreign exchange (FX) specialist during these politically turbulent times.

What kind of events affect the value of currencies?

Currencies are driven and guided by three main factors: fundamentals, interest rates and economic shocks, such as major elections, war – or a global pandemic.

Fundamental events include things like Purchasing Managers’ Index (PMI) numbers, unemployment and basic economic data. PMI is a useful barometer for economic status that can give us an indication of which way the market might go.

We also track the economic calendar throughout the month which includes events like Nonfarm payrolls in the US – an important figure released on the first Friday of every month which has a distinct impact on the direction of the market.

Interest rates have been hugely important for the last two years, as high interest rates have been driven by inflation, which has spiked due to many reasons including ongoing conflict and the lasting impact of COVID.

In response, central banks have raised interest rates to stifle spending and as a result we've seen UK inflation come down to 2.3%. Now, the market is calling for a reduction in interest rates. It’s an interesting time, because GDP is good, and the UK stock market is at an all-time high. Therefore, if we don't have an issue with growth, and inflation is under control, there actually isn't necessarily an economic reason to reduce rates.

What’s more, if interest rates are cut, this can have a negative impact, as it reduces the yield of the currency.

This happens because fixed income markets are linked to interest rates. Therefore, Central Banks can be cautious of changing interest rates, which might make things cheaper for the consumer, but that's not necessarily an economic reason for that decision.

It's going to be interesting to see how Central Banks react in terms of interest rates in the coming months. We’re in a “who goes first” situation between the Fed, European Central Bank and the Bank of England as to who cuts first.

Finally, economic shocks are unforeseen outliers in the market, things that happen very unexpectedly that cause a shock to the economy. Notable recent examples are Brexit, the war in Ukraine and the COVID pandemic.

How can elections affect the value of currencies?

To determine the likely impact of an election on currencies, we must consider how an election might affect monetary policy and how the market interprets the likelihood of growth and economic stability.

Currently, the market has priced in a Labour majority.  

Interestingly, when Rishi Sunak called the General Election, the market didn't falter and the pound hardly moved, which is a clear indicator that the market isn’t concerned.

There's a theory called Efficient Market Hypothesis (EMH), which in the simplest terms states that the market knows everything. When you have events like an election, if the market was unsure about the outcome, there would be much more volatility.

Is it too early to tell what impact the US election later this year might have on the dollar?

There’s a lot of media conjecture that Trump is going to get re-elected, even with the recent criminal charges, and there are arguments from an economical point of view that Trump may not be bad for the US economy.

In terms of the impact on the dollar, I think it’s too early to say right now. Currently, the focus is very much on the UK. Markets tend to focus on one or two things at a time and inflation and interest rates are still a big topic.  

Why is it important for expats to understand how currency might be affected by events like elections?

For any expat moving money internationally, the most important thing to look at is the timescale of when the transaction will take place.  

If it's real estate related, that can be months into the future.

My guidance is always to get a good understanding of the market as it stands right now, and the more significant events that may occur over the medium term.

There's a propensity for anyone that's trading in currencies to focus purely on rates, but there's not a huge amount of value in that alone.

It's more important to look at where the funds are going to or coming from, and any potential compliance friction associated with trading there. It is essential that the necessary paperwork is in place to ensure the transaction is seamless.

In the last 10-15 years, the banking system has only gotten worse from an efficiency point of view, mainly down to compliance becoming incredibly strict. Therefore, there is an onerous emphasis put on paperwork that determines the reason for transactions and proof of wealth. This is where, in my opinion, the real focus needs to be.

Ultimately, we don't have that much control over rates. It's important to know why the pound is trading where it is and where it's likely to be over the short/medium term, so we can take all the information we have to help make the best decision possible, but there are no absolutes, and there's no right or wrong.

Remember, there are only three things that markets can do: go up, down, or sideways. It’s important to ascertain where the market is given your timeframe, however the real value is in making sure the paperwork and potential compliance friction is removed, which is also where banks do a poor job.

Why should expats engage an FX professional when moving large amounts of money from one country to another?

The FX industry has evolved from the banking system to a broker model. Within this model you have remitters, who do a fantastic job at transacting smaller amounts of money, but when the numbers get larger, compliance becomes particularly strict.

We exist to help people focus on the operational aspects of moving a large amount of money internationally, which can be very daunting.  We provide a high-touch consultative service that focuses on the client’s situation real time, creating a stress free and informed transaction.

We are able to digitally track funds, understand the ins and outs of where the funds are coming from and where they're going to, and ensure we make the best recommendations to prevent any holdups or any restrictions.

That’s the value of engaging an FX professional.

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