The Impact of Elections on Foreign Exchange Markets

Elections can significantly impact foreign exchange (Forex) markets due to their influence on economic policy, political stability, and investor sentiment. Here are some ways elections shape Forex market dynamics:

The Impact of Elections on Foreign Exchange Markets

1. Introduction

Elections have become less predictable, and the immediate impetus for this study is the upcoming general elections in Greece. General or parliamentary elections in the European Union seem to end the process of economic and political uncertainty. Democratic processes, at first glance, seem to express broad societal views, but in recent years, international markets have become an equally important source of information. As a result, all securities that provide information can anticipate future changes in economic policies. Specifically, a country’s share of holdings in a foreign exchange futures or options market can be used to assess the economic policies that are most consistent with the forecast financial information of public opinion polls.

Concern arises because a portfolio adjustment is made as a result of buying the currency of a reserve currency-rich country during the four-week period preceding the resolution of the political risk. The approach is part of the broker’s research, but fundamental news is used much earlier than the election results. It measures the impact of election results on high-frequency US currency portfolios during several days, and the study is part of a growing literature that examines the role of various structural changes in the exchange rate. Commercial and speculative traders face large peer-to-peer transaction costs in the future, and the returns to dealers must be exploited from settlement to settlement. To take advantage of the opportunities caused by the revelation of information and to stabilize the international financial system, trillions of transactions are processed every minute in the interbank foreign exchange market.

1.1. Overview of Foreign Exchange Markets

Foreign exchange markets (FX markets) are the world’s largest financial markets. The latest estimates suggest that on average over 1.7 trillion US dollars of transactions occur in FX markets daily. They dwarf most equity markets, which trade at most a few billion US dollars daily, and have average transaction sizes that are an order of magnitude larger than equities traded. They are also by far the largest arena of speculative investment. FX markets also facilitate trade flows and foreign investment, which such flows are results of, and in large measure enable the internationalization of these operations.

Though in one sense large, FX markets are not a single continuous market. Rather, they consist of distinct markets that supply foreign exchange for a variety of purposes with varying risk exposures. Banks and other dealers supply these markets and are the central intermediaries of FX markets. One impetus to the creation of separate corporate markets occurred when it was ruled that the realized losses by US banks on their own foreign exchange holdings were non-deductible capital losses. This rule encouraged US banks to deal with the non-bank public in a corporate or consumer market, since the banks would bear less exchange rate risk in this market than in the bank-related markets.

1.2. Importance of Elections in Forex

Section 1: Introduction

Elections typically occur in most countries at least once every four years. Such a political cyclical event has the potential to generate significant swings in the exchange rate. The large swings of the Canadian dollar at the beginning of 1993, around the first round of the French elections in 1995, or those of the Russian rouble at the beginning of 1996, are not rare examples. The existence of such exchange rate swings requires an examination of how large elections really are in price formation on the foreign exchange markets.

Section 2: Importance of Elections in Forex

Elections are conventionally important political and economic game-theoretical events at both the national and international levels. In most cases, they are voluntary, strategic, and well-defined events. At the national level, usual decisions involve the choice of the government, the party, or the president, with specific potential economic implications. Such decisions affect both internal and external economic policies. Internal policies involve issues such as fiscal policies, monetary policies, and international economic policies. Typically, governments, particularly when close to an election, conduct countercyclical economic policies to ensure their re-election. Besides this, governments are typically willing to spend more than to tax because they can use the budget deficit to sustain their political survival. Sheer election cycle theories have been developed to provide a theoretical framework and empirical verification of how these discretionary and monetary policies are manipulated by successive governments.

2. Theoretical Framework

Given the closed nature of binary or multi-candidate political contests, we would expect investors and consumers affected by government economic policies to spend some effort to correctly anticipate the outcomes and compute future policy impacts of divergent policy alternatives associated with the various candidates. Hence, there should be a demonstrable effect of an impending election on the prices of financial assets and on foreign exchange markets. This is particularly true of foreign currency markets, given the permanent nature of changes in currency exchange rates and the fact that realized future policies are generally uncertain until election day, unlike the situation with interest rate decisions, which may generally be anticipated with some assurance by market participants.

There are several methods one might pursue to test the hypothesis that the information from election years is different from the signals associated with longer-term holdings or anticipated policy differences to be expected from the competing parties. The purchasing power parity literature suggests traders are interested in a long-term equilibrium rate that incorporates policy differences. Hence, if an immediate change in the direction of the dollar is associated with an election, and the equilibrium rate produced by the various purchasing power parity methodologies ends up predicting the exchange rate in the direction in which it moved immediately post-election, then we could conclude that a policy change was anticipated, but its political resolution before the expected time of occurrence contradicted expectations, resulting in a temporary deviation from PPP. If the change persisted into the future, then this would be a clear indication that there was a shock to expectations generated by the election regarding future government policy that was not anticipated prior to the election.

2.1. Efficient Market Hypothesis

In the foreign exchange and other financial markets, one of the leading theories is the “Efficient Market Hypothesis” (EMH). The strong efficiency hypothesis of the EMH argues that as all information is impounded into price, it should have no predictive power. That is, if only “news” contains information, as soon as that news is released, the gathered consensus of market participants should be revealed in the market price, and the authoritative announcement should be powerless to move the market. But while the strong version of EMH has to be considered unrealistic, the weak form holds that it is very unlikely that any technical trading method should be able to produce regular profits. The conventional tests of the EMH have consequently been statistical.

However, a number of studies have found that prices very often move irrationally in the short run; such that the weak form appears to hold in the long run, but are quick to add that this is not at all inconsistent with the hypothesis that news travels quickly enough such that there are no profits to be made from it. Indeed, this paper demonstrates that very often it is not firms who react to election news and adjust their prices, but rather speculators. At the same time, while the EMH does not require that the news should be “rational”, that is not at all to say that data can be ignored. This was the major criticism of the EMH offered by Fama, and subsequently there has been an ongoing debate.

2.2. Behavioral Finance Theories

This theory suggests that the effects of investor sentiment on election results and the underlying economic conditions that these responses reflect will in turn impact exchange rate movements. Sentiment influences investor expectations. It has generally been found to increase the influence of these political determinants. Sentiment is often influenced by institutions that structure ideas and symbol systems of meaning. When political events induce a higher level of these sentiments, they reinforce the influence of investor expectations on the foreign exchange market. The relationship between investor sentiment and foreign exchange movements is thus non-stable.

It is also stressed that though both political and economic conditions are likely to have an impact on exchange rate movements, they do not assume the existence of a ceteris paribus relationship between foreign exchange management and political events, which is usually observed in conventional relationship tests. Instead, it is noted that terms such as expectation, volatility, and information are absent from most research regarding this area. These observable influence values in the range suggest behavioral factors explaining the election effect. Political determinants (behavioral factors) are not guaranteed to have an immediate effect on exchange rates when a large group of swing voters are in situations where there are no changes in these political determinants.

3. Empirical Studies

In this section, we review the empirical literature on the impact of elections on exchange markets. Our review is based on two criteria that we believe are essential for conducting a comprehensive review: first, the type of exchange rate measure used, and second, the type of election event analyzed. By type of exchange rate measure, we distinguish between exchange rate level measures, such as spot, forward, and interest rate differentials, and exchange rate volatility measures. Additionally, by type of election event analyzed, we divide the studies into the pre-election and post-election period analyses and distinguish between national and sub-national level elections.

Election events take place at different points in time and differ in their importance to the domestic electorate as well as to international investors. National elections that entail a change of executive for a country are arguably the most important. Such events involve presidential and parliamentary elections in democratically ruled countries, as well as alternative institutions in non-democracies. Sub-national elections, which include local and regional elections, arise from decentralization, a process that involves the delegation of authority and resources from the central government to lower-level political authorities. Consequently, political commotion at the sub-national level can also affect a country’s credit risk.

3.1. Case Studies of Election Outcomes

Although each election is unique, there are some general patterns that provide insight into how election outcomes are likely to have affected exchange markets in a select few countries. We have already discussed both the Italian and French parliamentary elections in 1986, which had the usual market-moving outcome of defeat for the government. In both cases, the reaction of exchange markets was modest and short-lived, reflecting possibly the widely anticipated upset in each case as well as the fact that the subsequent changes in policy would almost certainly be in the same direction as those that had occurred under the previous administration. The return of the Conservative government in the British general election of 1987 was perceived by the markets as a confirmation that continuing Conservative policy in favor of lower inflation would be generally favorable. The response of exchange markets was buoyant, reflecting the perception that the enterprising rather than cozy policy would prevail. Since the Conservative government had been expected by opinion polls to gain an outright majority, the size of this majority surprised the market and further strengthened the existing majority. This increased responsiveness and efficiency in deciding economic policy was also perceived as a dollar-positive development.

3.2. Statistical Analysis of Election Periods

This section tests the weight of the election cycle effect in the foreign exchange returns. The null hypothesis that the dummy variable, incumbent, has a zero coefficient was tested for the total sample and the separate subsamples for the franc and the yen using the annual data for 1973-2000. The estimation allowed for the variation of the presidential elections in Austria, Belgium, Finland, Luxembourg, Norway, Portugal, Spain, and Sweden. The null hypothesis was tested for the low-frequency data for the pre-Euro period, i.e., for the total sample and the separate subsamples for the franc and the mark using data for 1987-1998. The change in the election term of Spain in 1982-86 was ignored because of the lack of consistent data on foreign exchange rates.

The examination also tried to assess the regularity in the midst of the election term, which is likely to persist in the parliamentary systems characterized by the high turnover in government readiness. They recoded preelection as 1 (0) for the first quarter of the election year. This binary proxy variable for the tenure of the government lists the fact that the elections in France are held in May while the German polls are scheduled for September. There were two realizations of the proximity index, i.e., 27 for the French six-year period and 35 for the German four-year period. Most of their values close to one were associated with the first type of elections. There was a significant negative reaction on the market represented by the current changes in the currency returns. The coefficient accompanying the dummy variable for the first quarter was negative and statistically significant.

4. Key Factors Influencing Forex During Elections

Trading on the forex and other financial markets is determined not only by objective economic and political factors but also by the expectations produced by them. These expectations can give rise to sharp fluctuations in exchange rate quotes in the absence or presence of strong fundamental reasons for this, that is, when data on the key indicators for a country is affected by a release season. The close approach of elections or political events triggering concerns over internal political threats within a country’s financial and economic system normally causes these fluctuations. Yet financial and economic structures are basically the highest indicator of a country’s independence as a power, and such concerns raise the natural question of the impact they have on a state’s currency, which serves as the world’s number one reserve asset.

These expectations almost ineluctably increase foreign investors’ uncertainty towards economic system parameters and national currency dynamics and can reduce the demand for a state’s securities, also resulting in a long-lasting increase in exchange rate quotes. On the internal forex market, this often leads to mass buying of foreign currency and a depreciation of the national currency. This situation is particularly critical for those states with a high foreign debt that effectively service it through conversion against their national currency. Besides, these processes involve substantial threats of reducing the financial sector’s willingness to extend loans to domestic industry, putting pressure on interest rates and bringing forward the realization of already tested monetary technology, making the rates less market-driven and more inertial. In turn, currency fluctuations also feed into inflation through a price rise in imported goods.

4.1. Political Stability and Instability

Researchers have attempted to refine the measure of political risk and to distinguish political instabilities from political changes. The reflection of the distinction in financial and exchange rate markets is of particular interest. They highlight the market consequences of political stability and instability. They note that the financial market responds differently to political events leading to political stability and political events leading to political instability. These distinctions extend to the forex market as well. The so-called political tension index (PTI) is the simplest and most intuitive way of distinguishing instability from maintaining the status quo, i.e., the risks associated with a change in policy versus the non-occurrence of a change in policy. They show that the increase in political tension represents an increase in future risk. These findings support the work of others who showed that the political tension index has a significant negative impact on portfolio and capital flows.

However, changes in political tension, i.e., an increase or decrease in the likelihood of a political event, also affect the value of the assets of the parties. When PTI increases, the value of rights and claims, to which those actors have effective political power, decreases. Already, the expectations of power and, consequently, the capital value of these assets should decline. It should be noted that assets cannot be sold on the market for a specific period. So effective trading on PTI is a strategy for investing in trend formation, setting no specific time limit for trading. Prior to the PTI increase, the accumulating investment establishes a market positioning. There is an increase in risk. On the other hand, the market response to the appearance of this event is quite contrary to the formation of a trend. Once the PTI is released, the political actors acquire liquidity rights. A larger governmental share of these contracts has a share in the formation of a governmental inception for the reduction of the liquidity premium. The market becomes more adaptive than reactive. On the day the PTI is released, it matches the sale of liquidity rights by accumulating ownership rights more precisely with those they have just sold in the market.

4.2. Economic Policies and Reforms

The Impact of Elections on Foreign Exchange Markets

Governments play a central role in the economic policies of a country. The way in which economic policy is implemented greatly influences the quantity and quality of economic indicators like the flow of foreign funds, growth rate, employment rate, current and budget account balances. The characteristics and qualifications of individuals in key governmental positions play a significant role in determining the economic policies and adequacy of a nation.

During election periods, market expectations about the country’s regime could change because of the differences that could potentially emerge between the results before and after the election. In contrast, two opposing parties can bring different sources of political power. A broader spectrum of decision-making processes, including problems like unemployment, income, and long-term policy resulting from exchange and interest rate fluctuations, can be seen during the election period. Therefore, the progress towards increasing the competitiveness of the business environment, which will be formed as a result of the election, will have a significant impact. This perception, which reflects the market’s expectations about the future, reflects short and long-term equilibriums in the exchange and interest markets.

5. Volatility and Risk Management Strategies

For hedging purposes, the principal concern is the development of appropriate risk management instruments. The two most important strategies for managing volatility on exchange markets are forward retranslation versus time diversification. A forward retranslation strategy consists of estimating the anticipated volatility of a foreign investment at a point in time and then protecting the portfolio with exchange transactions and forward exchange agreements covering the period ahead. A proper assessment of the investor’s characteristics and knowledge of the behavior and dominant factors on exchange markets would seem to be necessary, but the fact that the expected volatility is a uniformly consistent forecast might be a very strong argument in favor of retranslating the value of financial flows.

Diversification is the principal technique used by professional investors. By buying international assets over a period, an investment portfolio will have its average and expected returns diversified, and its performance and the risk-return tradeoff may be improved. If applied to all international assets, this strategy could lead to a strong real convergence of exchange spot rates, verify the forward rate—spot rate relationship, and thereby lead to the disappearance of a forward market. The main problem, however, is that the management of international portfolios is currently being given a very difficult time by the restraint achieved on domestic financial markets, by the curing of the valuation rule of insurance and the banking rules, and by the strong profitability of national capital markets.

5.1. Volatility in Forex Markets

The volume of trading on the foreign exchange markets and the availability of detailed price data make the foreign exchange market an ideal laboratory to analyze the presence of and the information content of various economic indicators. Given that the daily rhythm of the markets is well known and almost all important news is announced around the same time worldwide, it is also an ideal environment in which to study truly unexpected as opposed to expected news or news that is not perfectly forecast on a day-to-day basis. Most studies of the effect of economic announcements patiently distinguish expected from unexpected news, and they measure the reaction to news in a variety of ways, usually all consistent with an efficient marketplace. The effect of economic events on volatility, in general, and on the shape of the volatility term structure, in particular, are evident in many financial markets. However, since the flexibility of the forex markets adjusts worldwide, the effect is most visible in forex data. Small open economies display a definite election effect in their foreign exchange markets. Significant large positive returns before central elections are followed by positive returns, and insignificant before regional elections. Inefficient forex markets for very frequent but ultimately unanticipated data suggest an obvious trading strategy. When data are scheduled, the forex markets should fully incorporate the expected information. However, there should be an inefficiency and potential trading opportunity when the announced news is not released or is released contrary to survey projections.

5.2. Hedging Strategies

Corporations operating internationally often find themselves with little option other than employing foreign currency market hedge strategies to offset the risk of adverse exchange rate movements. This risk is potentially heightened during periods of major market volatility, such as that which often signals the run-up to national elections. One often-quoted strategy used by corporations is to lock in a future delivery date for an identified cash flow in a foreign currency. Alternatively, the short-run weight of a financial decision may be very high, and hence, the foreign exchange contract more accurately reflects a partial, tailored position in the financial market. Irrespective of the particular reason for proceeding, the corporate need to exchange the currency at a future date is matched by another party willing to accept a payment in that currency at the same future date. It is the forward premium and other considerations that will collectively determine the forward exchange rate negotiated.

These risk management strategies potentially involve injecting even more volatility into the foreign exchange markets as the activities of the corporations are superimposed onto each day’s natural foreign exchange market activity. These hedge strategies effectively enhance the ability of the operators to ‘weekend’ in other currencies. Hence, ‘hedge speculation’ is a phrase often used to describe the actions of the corporate bodies operating in this area. With few potential counterparties, the spot foreign exchange dealers may well be required to shoulder the brunt of these activities until the future cash-flow deadlines are achieved. When no counterparties are available to absorb the excess supply of a particular currency, market volatility is predictably the result, even if the corporate actions are taken with all the necessary efficiency and caution. Adding perhaps the emotional dimension of a national poll to the issue cocktail, the scene is set for a spike in short-term foreign exchange volatility.

6. Role of Central Banks and Government Interventions

The government of a country has some control over the authorities who are responsible for making announcements of market moves. There are times when a government experiences difficulty and its spokesmen wish to spread the prospective news when the market gives no comfort that an appropriate decision reflecting the problem is imminent. Except in the area of exchange rates, the central bank is supposed to be independent in influencing the underlying market forces. Thus, only in the exchange market will a government see a way of gaining direct intervention to influence events. We are more concerned with the direct exchange rate activities associated with government intervention. Such intervention can take a number of different forms or a mixture of forms. They come under three main categories: spot operations, forward or swap dealings, moral suasion, and foreign exchange and gold reserve operations.

The highly organized spot markets have a limited capacity to absorb sales or purchases of foreign exchange without affecting the exchange rate. Foreign exchange volumes are much greater during the day than at night. Central banks can make overnight operations that can temporarily influence market conditions. Such operations are generally limited in volume and price off the normal spot market rate. Forward and swap operations can take place to spread the influence over time. Central banks can also undertake market operations involving foreign exchange and gold reserves to influence exchange rates, particularly where these are up against taking big risks. Such operations are also done for emergency purposes in an endeavor to rescue a currency from a free fall.

6.1. Central Bank Policies

Following previous studies, the study assumed that monetary authorities adjust the level of intervention in the foreign exchange market according to the exchange rate arrangement. A freely floating regime, as a typical example, is characterized by the decision to leave almost everything on the market. In contrast, a managed float is characterized by an active exchange rate policy. In freely floating systems, therefore, the exchange rate is almost equal to a random walk, and central banks have no incentive to affect the degree of exchange rate variability. However, literature in the foreign exchange market has argued that central banks in managed floating regimes intervene with the objective of maintaining targets or limiting rate movements to avoid fluctuations.

A switch regression analysis was conducted to evaluate the changes in the official foreign exchange interventions of various countries over the observation period. The main conclusion was that, for a given shift in the exchange rate regime, an economy with stronger fundamentals used policy intervention to balance the volatility. However, in response to both the cyclical and non-cyclical phenomena, economies with more sound policies were found to have used intervention in the past, mainly for intervention sales. The main conclusion is that countries with stronger fundamentals are using less as a policy tool to support the exchange rate.

6.2. Government Interventions

One important issue, which has received much attention and on which a large literature exists, is the analysis of the nature of government intervention itself. We can adopt one of two positions on this question. According to the first, simplistic position, the government intervention equation is entirely passive and governments are, in practice, relatively powerless. They make mistakes in the sense that they can forecast poorly the actions of the foreign exchange markets and are informed of the possible high costs of even relatively large government interventions. Therefore, government interventions have minimal impact on exchange rates and will not really prevent a major correction of the basic problem.

The alternative position is that games are played between government and foreign exchange markets – the markets are the drivers in the road and governments are merely passive. Central banks must act in the crucial fundamental time dimension of the current economic shock and small movements can rapidly turn into large ones, particularly as foreign exchange markets are prone to respond to crowd psychology. A pure reduction to this question of the unrealistic character of government interventions within the short-run fluctuation in the foreign exchange rate is not whether the intervention decisions are passed or the basic tools are clumsy.

7. Technological Advancements in Forex Trading

The rapidly growing Forex market has integrated a number of advances in the area of telecommunications and information technology. It has seen the development of a fast retrieval and instantaneous data processing system with international backbone networks. There is a clear trend among users towards the use of laptops and cellular phones, and also towards the use of communication software to be able to access the systems from anywhere in the world. The use of real-time data for decision-making also spreads rapidly among users. Although there is significant noise in most real-time price data, in these price movements there is also important information that is useful to Forex traders who have learned how to differentiate between noise movements and those that carry significant information. The number of people accessing the Forex market at different times from different places in the world is constantly increasing. With access and technology, the user can view and access these Forex systems with a point and click of their mouse. Moreover, most Forex quote providers can, on request, also provide charts of most currency exchange rates. With additional software, traders can also trade concurrently over the phone. Even small currency exchange and Forex brokerage companies are beginning to use and develop Forex trading systems on their own, or purchase them from other companies and modify them for their own needs. There are also a number of companies worldwide that aim to provide information by establishing a global network. Small and large vendors have established operations, based anywhere in the world, in data provision, or with real-time charting and trading software. The number of people interested in this market is really interesting; international end-users and traders who utilize the Forex market consist of exporters and importers, multinational companies, foreign direct investors, speculators, foreign exchange brokers, etc. The international clearing system, like the real-time system, which can financially facilitate the system’s operation is really interesting.

7.1. Algorithmic Trading

The Forex market is no longer made of humans but of algorithms. In 1970, the New York Stock Exchange became fully electronic and showed that human broker floors and colorful ties are disposable when serious computer work beckoned. Today, high-frequency traders whose algorithms swap currencies in milliseconds account for 40% of the market. The less quantitatively savvy could blissfully ignore what an algorithm did on July 31, for example, if these did not amplify market ecstasies and crises.

Automated trading has put a large number of traders in the Forex market, and earlier studies concluded that this improves liquidity. The fact that exchanges now gang up to have automatic liquidity providers or to impose resting-time restrictions on orders only proves this point. This liquidity effect is, however, unsatisfactory for the following reasons. First, central banks reduce this liquidity effect with their actions by as much as 87.7% on average (14.2% for the Fed and 110% for other central banks). Second, the liquidity improvement does not relate to any signaling effect on information. When the market expects information, say a few days before meetings, our policy information proxy jumps up and is significantly positive. At this stage, policy meetings have no private information, so the market’s jump can only come from media or analyst releases. Of these, some are media while others have actionable consulting services, which means that on meeting-day morning, both spokes have released some messages to the market. The news stories are part of a leading standard and have autocoded tags.

As expected, pre-meeting coverage is more credible before meetings, so counterintuitively, more of the messages should get onto the index the Tuesday after covering a meeting than the Friday before. The two samples are, however, practically indistinguishable, so the pre-meeting rise in the policy information index is credible in reflecting a genuine information value created by automated trading. So far, beggars are picky. A paper says machine trading reduces prices, and a report provides first-time evidence on price dislocations pre-meetings. We can, therefore, ask a few more interesting questions.

7.2. High-Frequency Trading

To our knowledge, no discrete-time rational-expectations model with dynamics in the underlying determinants of exchange rates has succeeded in generating discretely sampled realized estimates of intradaily volatilities and other higher moments. We view such estimates as potential challenges to standard continuous-time equilibrium models, as they may be difficult to reconcile with the typical forecasting performance and the small sample biases that are part and parcel of discrete-time tests of equilibrium. But contending with this distinction between realized and risk-neutral processes is another issue that we are not yet equipped to address. The rest of this paper is organized as follows. Section 7.2 exposes the frequent accessing of microstructure data as an implicit consequence of the compromise that high-frequency traders face between immediacy costs and information revelation. Section 7.3 sketches the implementation of the real-time VAR-based continuous-time model suggested by large-n asymptotic theory for stationary processes. Our main model choices largely reflect the restrictions that we can identify clearly with high-frequency sampling. Section 7.4 concludes and reaffirms high-frequency exchange-rate data as a vital tool for the modern open-economy macroeconomist.

8. Regulatory Frameworks and Compliance

Authorities often mandate market practices in order to assure efficiency and fairness. For example, since the 1970s, a market liaison group based in the United Kingdom has focused its attention on market misconduct, particularly intervention. Since then, a significant amount of market practice has evolved, notably so-called “trading disciplines.” The backbone of those disciplines in the spot market is a document forwarded by various FX Committees based in different regions. It is non-legally binding and “does not, of itself, constitute regulation, and enforcement of its contents is not within FX Committee members’ remit.”

8.1. International Regulations

Several international regulations have now been agreed on to strengthen the international financial systems. Heading the list is the creation of the European Monetary Union. These regulations prohibit capital and exchange rate measures by the signatories. Between mid-1998 and end-2000, another 27 countries joined, totaling 42 countries that are now bound by these regulations. Five countries have joined since, and at the end of 2002, a further 13 were official candidates. Also, a number of further proposals are under discussion. This includes an asymmetric approach of the Asian currencies uniting, but without the pegged or floated US dollar. Having these anchor currencies floating against each other could keep the entire system relatively stable, although this is no replacement for a global agreement on stable exchange rates. Five countries have joined the EMU since the introduction of the Euro.

member states before the start of the EMU on 1 January 1999. All these members introduced the Euro on that date. The European Economic and Monetary Union started on 1 January 1999. The following member states are also members. These conditions make it likely that industrial and currency bloc formation becomes more important in the very near future, a situation where small open economies often see that the gains of real sustainable macroeconomic convergence exceed the short-term competitive advantage of under- or over-evaluated currency.

8.2. Compliance Requirements

The previous section discussed the information in the Instructions of the Currency and Foreign Transactions Reporting Act concerning the requirements of the law and urged reporting officers to know the material in the Act. This section discusses the need for, and the importance of, setting up effective compliance procedures to ensure that the requirements of the Act are met. Inadequate or ineffective compliance procedures are likely to result in substantial risks being taken by the bank despite good intentions and even internal knowledge of the rules. These risks stem from the existence of substantial fines in the Act and the ability of federal law enforcement agencies to be intrusive and confrontational in seeking the information needed to ensure that the fines are paid.

Although the checks that are normally used to prevent money laundering can prevent currency reporting, the two sets of objectives are not the same, and an institution cannot ensure that it is meeting them by simply concentrating on the requirements of one rule. The volume of currency in transactions may be too great or erratic for the activity necessary to detect money laundering to serve as a control on currency reporting. The risks of robbery may justify meaningful controls on the amount of currency on the teller’s line that cannot be quantitatively justified by the need for money laundering controls. Through effective additional controls, ones that set limits on the permissible size of transactions or other relevant criteria, the risks associated with the compliance of currency transaction reporting requirements can be markedly reduced.

9. Case Studies and Real-World Examples

A good example of the delivery of the policy is the participation of the UK and Sweden in the European Exchange Rate Mechanism. Both countries were shadows of the ERM well in advance of formally joining the system. The UK fixed an important date first, and the market had little choice except to hedge for the possibility that sterling would have moved through its effective floor by this date. Sweden followed the UK into the ERM primarily to import some anti-inflation credibility and to counteract the argument that the conduct of macro policy would be decided by a political federation instead of by the government. Forward markets indicated that the Swedish government would regain a considerable amount of monetary autonomy by having access to positive real interest rates, hence helping to ensure that referenda and an eventual political union would be approved.

In a similar analysis, the British and Swedish governments would also be able to present a positive story in the referenda and Swedish election. There are some small differences between the two cases. First, both the UK and the Swedish governments were not prepared to actually join the ERM at any cost and were prepared to bite the bullet if the market was too lax. To quote a source, ‘the floor and cap are comforting, but the most important parameter is the width of any hypothetical tunnel to a deeper relationship between the peoples of Europe.’ Second, the Swedish government was prepared to add to its credibility and buoy a flagging position in the opinion polls in 1993 by hinting that the only conditions that the Riksbank needed to hit its own internal target range were those that made the horizon date plausible. It did not form the basis for fiscal policy.

9.1. US Presidential Elections

Presidential Elections US Presidential Elections Since 1980, the dollar has significantly weakened following presidential elections, regardless of the party affiliation of the winning candidate. This apparent election effect reflects two elements. The first is the increased stability of the dollar’s exchange rate in the post-election period. The dollar is notorious for depreciating approximately every 12 or 13 years. Dollar declines have occurred at least once during 12 of the last 13 presidential terms, and the infrequent exceptions all involved term durations of 4 years. Since 1980, only the re-election of an incumbent has produced an extended period of political stability. Following the election of a president from a different political party, the dollar tends to decline for several years. Note that this pattern of declining and slowly appreciating dollar involves the real, trade-weighted value of the dollar, so the political effects are independent of secular macroeconomic and exchange rate factors.

9.2. Brexit Referendum

The UK Brexit referendum took place on June 23, 2016. At the time of the vote on leaving the EU, opinion polls and betting odds overwhelmingly suggested that the UK would continue its EU member state status. Moreover, several opinion polls conducted in the week leading up to the referendum confirmed the dominant position of proponents of staying in the EU. Consequently, the foreign exchange market viewed the leave vote as a surprise. The pound devalued considerably. A single day observed depreciation of the pound by a magnitude ranging from 8% to 12%. By the end of the calendar year 2016, the GBP/USD exchange rate had fallen by 16% compared to the day before the referendum. The depreciation of the pound resembled the magnitude of the Bretton Woods collapse on August 15, 1971.

Previous empirical studies that scrutinized the topic concluded the remarkable depreciation of the British currency: focusing on periods before the referendum, the stock market evaluation, and the analysis of long-term risks associated with leaving the European Union. However, once more data became available, a controversial picture of Brexit’s impact on the pound emerged. Although the pound significantly devalued during the few days following the leave vote, in the longer term, the exchange rate merely fluctuated and exhibited no trend. There had been high-volatility jumps which resulted in technically excluding from our study price movements beyond one standard deviation. There have been days on which the exchange rate surged vis-à-vis the US dollar, contributing to shrinking the previous devaluation. For example, after the Bank of England hinted at the possibility of interest rate hikes, the pound recovered slightly. The highest pound appreciation occurred on December 6, 2016, prompted by the UK government’s pledge to consult Parliament before signing a Brexit agreement. During the year, there have been several sharp rebound days. For instance, the pound strengthened on January 17, 2017, when the British prime minister delivered a speech in which she unveiled the government’s plan for withdrawal from the European Union.

10. Conclusion

Recent events demonstrate the potential importance of political developments for the changes over time in the structure of expectations. This paper has considered two of the many channels through which expectations might change in an election. Traditionally, much attention has been given to the roles of new information about economic fundamentals and policy, and the influence of political events on negotiations between trade agents in determining the pattern of relative asset returns. The discussion and evidence provided above make it clear that the most recent empirical work on the microeconomics of foreign exchange transactions and the latest theory of asset pricing that explicitly distinguishes between the roles of economic fundamentals and the political sector in determining exchange rates suggest that we should incorporate changes over time in the structure of expectations as a potentially important third channel through which elections could influence exchange rates.

By incorporating changes over time in investor expectations about the outcome of close elections into the standard event study methodology that is used to test the hypothesis that political events have no effect on the price of risk, this paper has found evidence that investors have held different asset structures than they otherwise would have. Consistent with a lack of judgment on the part of these individuals, these structural changes have resulted in the generation of differences in returns among centers that are consistent with equilibrium. Moreover, foreign exchange transactions were sufficiently endogenous, and the profits from trading against superficially lower transaction costs were too low to be held responsible for these observed patterns of returns. Our power to reject the null hypothesis that elections have no effect on the price of risk is weakened, however, by a number of limitations in our tests. Nonetheless, the evidence continues to suggest that monetary models that ignore political forces and their impact on investor expectations in general, and the structure of asset markets at election time in particular, will be inadequate.

10.1. Summary of Findings

This research examines the influence of U.S. presidential elections and elections in the United Kingdom on the foreign exchange market. The analyses are based on the hypothesis that rational agents in the foreign exchange market form anticipations of events and act in the marketplace before those events occur. By doing so, agents integrate their anticipations into market exchange rates in advance. Therefore, the influence of an actual election should be discounted in the market by the time of the election, and no significant announcement effect should exist. The classic “announcement effect” of the voting decision should be greatly discounted or non-apparent in the foreign exchange market.

The research draws results from daily high-frequency foreign exchange rate data that were collected for the U.S. dollar/British pound, U.S. dollar/Japanese yen, and British pound/Japanese yen exchange rates surrounding both U.S. presidential and United Kingdom election time periods. A variety of statistical techniques indicate that no foreign exchange market “announcement effect” is apparent. Macroeconomic intervention policy implications are discussed.

10.2. Future Research Directions

There is an emerging body of academic research that has shown that political events frequently have significant impacts on foreign exchange markets. Although not our main focus, this paper itself provides incremental evidence to demonstrate that country-level national elections can have significant and long-lasting impacts on exchange rates. The natural shortcoming of this particular study is that our findings are inherently based upon only 31 events, which can call into question the significant explanatory power of these results. One obvious avenue for future research is therefore to more broadly examine the long-run behavior of exchange rates around political events. This paper illustrates the use of integral data and suggests new questions that can be explored. The rich event data provides the basis to explore whether the scale or the nature of market doubt has a significant impact on how long the effect lasts. It could also be used to examine whether exchange rate probing behavior during the established periods has any noticeable impact on the duration of the effect. The event data could also be used to look at whether multimedia interactions of consensuses of exchange rate drives or the actions of policymakers have any additive impacts. Finally, the effect of the budget deficit on this event is not explored. If the effect is as profound as suggested, a relatively simple naked probability experiment could unmask some important adjustments needed to existing exchange rate risk management practices.

Impact on Capital markets after donald trump election in 2024

1. Political Uncertainty and Volatility

• Elections introduce uncertainty, often causing heightened volatility in Forex markets. Traders may react to the possibility of policy shifts, with speculation on the outcomes driving currency prices.
• This uncertainty often leads to increased demand for safe-haven currencies like the USD, CHF (Swiss Franc), and JPY (Japanese Yen) as investors seek stability.

2. Policy Changes and Economic Impact

• Elections determine the future of fiscal and monetary policies, which are key drivers of currency value. For instance, policies that impact interest rates, trade, and government spending can strengthen or weaken a country’s currency.
• A shift in political power may lead to contrasting economic policies (e.g., more aggressive fiscal stimulus or higher taxes), impacting currency valuation depending on market perception of their potential economic impact.The Impact of Elections on Foreign Exchange Markets

3. Trade and Foreign Relations

• Currency markets are sensitive to changes in trade policies and international relations, often highlighted during elections. Candidates may propose trade restrictions or renegotiate trade agreements, affecting currency demand and valuation, especially for export-reliant economies.The Impact of Elections on Foreign Exchange Markets

4. Central Bank Influence

• During election cycles, central banks often respond by adjusting interest rates or signaling monetary policy direction to stabilize currency markets in light of potential economic changes.

5. Impact on Emerging Markets

• Elections in major economies, like the U.S. or EU nations, often affect emerging market currencies. Investors may withdraw from riskier assets in emerging markets, leading to currency depreciation in these regions if election results lead to uncertainty or economic shifts in major economies.

Forex traders often monitor election cycles and adjust their strategies accordingly, making elections a key event in Forex trading. If you’re trading Forex, incorporating elections into your analysis can help you navigate this potentially volatile period effectively.

Elections can significantly influence foreign exchange markets due to the uncertainty and potential policy shifts they introduce. Here’s how elections impact currency markets:

Political Uncertainty and Volatility:
Elections create periods of uncertainty as the outcome remains unknown until the very end. This uncertainty often leads to increased volatility in currency markets. Traders and investors might hedge against potential outcomes, leading to fluctuations in currency values. For instance, during election periods, currencies of countries undergoing elections might see higher volatility due to political risk.
Policy Expectations:
Different political parties or candidates often propose distinct economic policies concerning fiscal spending, taxation, trade, and regulation. These policy expectations can significantly affect currency valuation:
Fiscal Policy: Promises of increased government spending or tax cuts can lead to expectations of higher inflation or economic growth, potentially strengthening the currency if investors anticipate these policies will be implemented.
Trade Policies: Protectionist policies like tariffs can lead to fears of trade wars, generally weakening a currency due to anticipated negative impacts on trade balance, whereas free trade policies might strengthen a currency by enhancing export competitiveness.
Historical Trends:
Historical data suggests patterns in currency behavior around U.S. presidential elections:
Republican vs. Democratic Policies: Republican administrations tend to start with a strong dollar which might depreciate over time, while Democratic presidencies often see an initial depreciation followed by appreciation. This is largely due to perceived differences in fiscal and monetary policy approaches.
Safe-Haven Movements:The Impact of Elections on Foreign Exchange Markets
During times of political uncertainty, particularly contentious or unexpected election outcomes, there’s often a flight to safety. Currencies like the U.S. dollar, Swiss franc, or Japanese yen might strengthen as they are considered safe havens. Conversely, risk-sensitive currencies like the Australian or New Zealand dollar might weaken.
Post-Election Adjustments:
After elections, especially if there’s a change in government, currencies might adjust to the new political reality:
Currency Devaluations: In some emerging markets, governments might prop up their currency before elections to show economic strength. Post-election, if the new government needs to adjust to economic realities, this might lead to a devaluation.
Market Sentiment: Once the election outcome is known, markets often react based on the perceived stability or instability of the new government, impacting currency values based on investor confidence.
Global Market Reactions:
The U.S. dollar, due to America’s economic influence, often reacts significantly to its presidential elections. A Trump victory, for instance, has historically been associated with a stronger dollar due to expectations of business-friendly policies and potential tariff impositions.
Strategies for Traders:
Traders might:
Use options markets for hedging against volatility.
Focus on safe-haven currencies or diversify into commodities or other assets.
Implement strategies like forward contracts to lock in rates during this uncertain period.

In summary, elections introduce a layer of political risk that can cause forex markets to fluctuate, often dramatically, due to both the immediate uncertainty of election outcomes and the longer-term implications of policy shifts. The exact impact can vary widely based on the specifics of the election, the countries involved, and the global economic context at the time.

The re-election of Donald Trump in 2024 has had several observable impacts on global capital markets, with reactions varying across different sectors and markets:

Stock Markets:
U.S. Equity Markets:
The anticipation and confirmation of Trump’s victory led to a significant rally in U.S. stock indices. The Dow Jones Industrial Average and the S&P 500 hit record highs, driven by expectations of business-friendly policies like tax cuts, deregulation, and a focus on domestic manufacturing.
Sectors expected to benefit included technology, finance, energy (particularly fossil fuels), and defense, as these areas could see reduced regulatory burdens and potentially increased government spending or policy support.
Global Markets:
Asian markets showed mixed reactions. Some indices like Japan’s Nikkei 225 and Australia’s S&P/ASX 200 rose, possibly due to optimism about global economic policies or specific trade relations. However, others like Hong Kong’s Hang Seng Index experienced declines, likely due to concerns over trade tensions, especially with China.

Currency Markets:
U.S. Dollar:
The dollar strengthened significantly post-election. Investors anticipated higher inflation and growth under Trump’s policies, which would necessitate higher interest rates from the Federal Reserve to curb potential overheating. This scenario typically benefits the dollar.
Emerging Markets:
Emerging market currencies faced pressure due to an expected stronger dollar and potential tariff impositions affecting global trade.The Impact of Elections on Foreign Exchange Markets

Bonds:
Treasury Yields:
There was an uptick in U.S. bond yields, reflecting investor concerns over increased fiscal spending without corresponding revenue increases, potentially leading to higher inflation and thus higher yields.

Cryptocurrencies:
Bitcoin:
Bitcoin reached an all-time high, spurred by Trump’s supportive stance towards cryptocurrencies, promising to make the U.S. the “crypto capital of the world” and hinting at a more lenient regulatory environment. The Impact of Elections on Foreign Exchange Markets

Specific Sectors:
Fossil Fuels vs. Clean Energy:
Fossil fuel sectors generally saw positive movements due to expected policy rollbacks on environmental regulations. Conversely, clean energy stocks like solar and wind companies faced volatility or declines due to fears of reduced government support.
Technology and Finance:
These sectors rallied on expectations of lighter regulations and lower corporate taxes, which would boost profits.

Market Sentiment and Strategy:
Volatility:
Election results initially increased market volatility, but clarity on the winner reduced this, leading to a more confident market environment.
Investment Strategy:
Investors might look towards defensive sectors like consumer staples, healthcare, and utilities for stability, while others might increase exposure to sectors expected to thrive under Trump’s policies.

Global Economic Implications:
Trade Policy:
Trump’s tariff proposals against China and potentially other nations could lead to increased trade tensions, affecting global markets, particularly those dependent on trade with the U.S.
Economic Policy:
Expectations of fiscal expansion through tax cuts and increased government spending could lead to higher economic growth in the short term, but also raise concerns about long-term fiscal sustainability.

The market’s reaction to Trump’s 2024 election victory underscores a complex interplay of policy expectations, investor sentiment, and global economic dynamics. These movements are based on both the immediate implications of his policies and the broader economic environment he inherits.