Together, the U.S. and Europe form the largest and most open bilateral trade and investment partnership in the world. Changes in U.S. policies and administrations have a deep and far-ranging impact on the economies and currency rates of both regions. Because of this, the U.S. presidential election every four years is a closely watched event for the short- and long-term implications it has for transatlantic exchange.
The Euro-Dollar Relationship
The depth of the interconnection between Europe and the U.S. is illustrated by the volume of trade and investment between the two regions. Europe is the U.S.'s top trading partner, with more than US$600 billion in goods exchanged directly between the two regions in 2015.
The U.S. registered a trade deficit with Europe in 2015 of US$150 billion. About 60% of all U.S. foreign direct investment (or about US$185 billion) went to Europe in 2015, while Europe sent US$300 billion to the U.S., or some 80% of total foreign direct investment in the country. In all, the "transatlantic economy" produces US$5.5 trillion in commercial sales around the globe and employs some 15 million workers across the two regions. The combined U.S. and European market is the largest in the world, accounting for about 35% of world GDP.
Because of the strong trade and investment relationship between U.S. and Europe, the euro-dollar currency pair is the most widely traded pair globally, with more than US$1.3 trillion exchanging hands daily. The pair represents about 24% all currency trading globally.
Overall, however, the dollar represents a greater weight in global trading. A daily volume of about US$4.65 trillion in USD is traded daily against all currencies, compared to US$1.80 trillion in euros.
A portion of the interdependence between the two regions stems from Europe's role as a key global trading center for goods such as oil, metals, and soft commodities in addition to its role as a banking and financial hub. Europe also has a sizable market of 500 million consumers, making it an important location for U.S. company affiliates that generate more than US$2.5 trillion in revenues from sales around the globe annually. Of nearly equal weight are European affiliates in the U.S., which are responsible for more than US$2 trillion in revenues.
How Have Recent U.S. Elections Affected The Euro?
The trajectory of the dollar often has a significant influence on the trajectory of the EUR/USD currency pair, because of the close ties between the U.S. and Europe and the importance of the dollar in global market. The euro was first introduced in 1999 to replace a variety of European national currencies with the creation of the eurozone.
The euro initially strengthened against the dollar following the election of Republican George Bush in 2000 and weakened against the dollar following his re-election in 2004. The euro then strengthened against the dollar in the periods following the election and re-election of Democrat Barack Obama in 2008 and 2012. The elections of both men, however, were accompanied by periods of market volatility, and the price trends following the election campaign periods didn't necessarily hold during the remainder of their terms in office.
Election 2016: What's At Stake?
While candidates from the major parties in the U.S. tend to lean toward preferences for certain policies during their campaigns, there is no guarantee they will be able to act according to those preferences when in office, nor that they will be able to influence markets in a particular direction.
Often, factors determined by the business and economic cycles and global events will override policy plans to guide the trajectory of markets. Considering this, the status of major economic indicators such as growth, employment, inflation, interest rates, government debt and the trade balance will play a dominant role in the electoral and market outlook.
Going into the 2016 elections, the U.S. has seen mostly tepid annual economic growth of under 2% and has remained in an environment of low inflation, steady unemployment and historically low interest rates. The U.S. public sector debt has reached an historic high of around US$20 trillion, or about 104% of GDP, and the U.S. foreign trade balance has remained in a deficit.
In this environment, the U.S. dollar has been perceived as strong against most emerging markets and developed country currencies around the world. Given this situation, any candidate's moves to tighten interest rates will likely be made with caution, and there may be strong pressure to raise U.S. taxes regardless of who is elected.
Europe has been in no less of a tight spot. Like the U.S., growth in the eurozone has remained below 2%, alongside flat inflation, near-zero interest rates and elevated debt at about 90% of GDP. On the positive side, the region has posted growing trade surpluses. However, it has also been plagued by elevated unemployment of above 10%. The euro has remained weaker against the dollar since 2015, but any move by the U.S. that allows the dollar to weaken significantly against the euro could hurt the efforts of European authorities to maintain strong trade, boost growth and cut unemployment.
While the U.S. is likely to see policy changes regardless of which candidate wins, a Republican victory would likely introduce faster and larger changes. However, much could also depend on the composition of the next congress and its willingness to expedite the plans of the new president.
An administration of Democratic Party candidate Hillary Clinton is seen favouring an extension of many of the policies that have already been in effect. Unlike the Republicans, the Democrats have not shown great interest in altering monetary policy at the Federal Reserve and have not shown urgency in altering the prospects for spending and the debt.
Clinton has mentioned an interest in reform at the Fed to make its decision-making structure more democratic, but this is seen as a longer-term initiative that would likely have a more gradual impact. One policy preference that could have a more direct impact on Fed actions is a Democrat preference for explicit Fed targeting of both inflation and growth objectives rather than only inflation objectives. However, such policy preferences may only be implemented over the medium to long term.
Additionally, Clinton (like opposing candidate Donald Trump) has made improvements in the foreign trade balance a central element of her campaign platform, which may limit her administration's desire to promote near-term interest rate hikes and a stronger dollar.
In his campaign, Republican candidate Donald Trump has emphasized an increase in domestic economic activity, employment and exports to boost growth. He said he would back an eventual change in leadership at the Federal Reserve and the reduction of the federal debt, but he hasn't committed to seeking immediate changes to monetary policy or reducing spending.
Meanwhile, part of his plan for stimulating the economy would involve a reduction in the corporate tax rate to 15% and tax cuts for the middle class. The plan would initially cost about US$3 trillion in lost revenues, but its aim is to eventually increase overall revenues through the effect of economic growth and rising tax collection. The timeline for the plan to produce effects, however, is unknown. Also, it is unclear whether it would allow for changes in the monetary policy path that could alter the trajectory of the foreign exchange rate in the near term.
Trade with Europe
Another concern for European interests is the U.S.'s commitment to promoting free trade.
Republican Donald Trump has lined himself up against expanding trade deals with an aim toward limiting competition from abroad and protecting American industry. Clinton has appeared as a political pragmatist on trade. She initially supported major trade agreements such as the Trans Pacific Partnership, and later withdrew support when it appeared opportune for her campaign. In an environment of growing protectionism, however, neither candidate is seen pushing strongly for expanded transatlantic trade deals.
One victim of the current mood may by the Transatlantic Trade and Investment Partnership between the U.S. and Europe, which has been under discussion since 2013.
Foreign Policy And Security Issues
Outside the realm of economic policy preferences, the candidates can also give signals regarding foreign policy that may have implications for the euro and the dollar. Over recent decades, for example, periods of heightened tensions and military intervention in Middle East have tended to increase the price of oil, which has a weakening effect on the two currencies.
Donald Trump has adopted a hawkish tone for dealing with overseas conflicts, but he has also suggested his administration would refrain from direct military intervention, especially in the Middle East. By contrast, Hillary Clinton has adopted a more moderate tone, but in some policy speeches has suggested taking more aggressive steps on military intervention abroad, such as imposing a no-fly zone in Syria.
A particular area of concern for Europe has been tensions with Russia. Trump has suggested a warming of relations between the U.S. and Russia is possible, while Clinton has highlighted the need to maintain a firm stance against bullying from Russia. On a related matter, Donald Trump raised questions over the U.S. commitment to maintaining a strong NATO alliance with European states that don't contribute significantly to the group. Clinton has said that the U.S. support of NATO provides a deterrent to aggression by Russia or other nations.
Before, During And After the Election
Following patterns common in past elections, markets have shown relative stability in the year leading up to the election. Traders, however, may look for increased volatility as the election approaches and possibly a selloff of the dollar if candidates or global events present unexpected new information about the economic outlook for a new administration.
However, if the U.S. adopts a gradualist stance to changing policy and recent trends hold up, traders may expect continued efforts by eurozone officials to maintain a weak currency in order to stimulate the euro economy in the longer term.
As revealed often in elections, there is usually a distance between a candidate's campaign rhetoric and his or her ability to execute stated policies.
Assuming the current U.S. presidential candidates can carry out their plans, Democratic candidate Hillary Clinton is seen as favouring the maintaining of existing policies, suggesting a continuation of the recent trend of a weaker euro in support of European growth objectives. A victory by Republican candidate Donald Trump is seen favouring a change in policies and conditions for the exchange rate, suggesting the possibility of a weaker dollar.
However, the current restrictive economic environment appears to cast doubt on how quickly change might be introduced by either candidate. This suggests traders should expect a gradual shift regardless of who comes out on top in the election.
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Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…