How Populism Impacts Exchange Rates: What Your Company Needs to Know

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Populist-led political change has driven global currency volatility

The increasing global shift to populist-led governments has generated upheaval for currency markets. Populist governments are now in place in the United States, Turkey, Brazil, Italy, Hungary and Poland. Mexico recently ushered in a new president, Andrés Manuel López Obrador, who ran on a leftist, anti-establishment platform. While the U.K. is not led by a populist government, influential populist campaigners for Brexit such as Nigel Farage were key to the Leave campaign's referendum victory.

In this article, you'll learn:

  • what this global shift means for currency markets;

  • how it may affect businesses; and

  • what your company can do to protect itself from populism-caused currency risk.

Populism rocks the boat

Populist governments spook investors because they represent a threat to the status quo. Investors like consistency and predictability, whereas populists tend to campaign based on an anti-establishment agenda. This increases investor belief that such leaders might negatively impact economic growth through the implementation of new economic, financial, political or social policies.

The Turkish lira (TRY) is a prime example. It began 2018 valued at 3.74 to the U.S. dollar (USD), but by November it slumped to 5.5, representing a colossal loss in value for the beleaguered currency. Turkish president Erdogan is known to take an unconventional view of how a central bank should operate, having said that interest rates are “the mother and father of all evil", and he has sought to influence the Turkish central bank by appointing his son-in-law as minister of finance and treasury.

Added to Erdogan's views on economic policy, another populist leader - U.S. president Trump - imposed tariffs on Turkish steel and aluminum, which economic observers believe drove TRY's descent. In this example, it is decisions by two populist leaders that have largely generated the TRY crisis.

What is most concerning is that a currency crisis like this is usually not localized to one or two countries. European markets fell as a result of the TRY crisis, and investors have been scared that it will lead to an emerging market contagion. If this happens, it will likely drag a host of other currencies down with it.

The wave of populism gripping Europe acts as a constant drag on European financial markets. Indeed, confidence in the euro was knocked when the populist Italian coalition government assumed power earlier in 2018. While uncertainty persists in the eurozone, currency investors are likely to treat the euro with trepidation. European uncertainty also has a direct knock-on effect on emerging market currencies.

There's no need to panic

While observers generally see populist movements as harmful to currency markets, there is historical evidence that they can actually be good. A financial study found that stock market prices tended to rise after the election of populist governments in their countries over the last 100 years, for both a two-year and five-year period.

Since Donald Trump became U.S. president in 2016, U.S. stock markets have enjoyed a period of sustained growth. At the same time, the USD has strengthened as investor confidence has soared regarding U.S. financial markets. While this is an example of where a populist leader may help boost financial markets, Trump's tariff wars have fueled uncertainty elsewhere in the world, for currencies including the Mexican peso (MXN), yuan (CNY) and Australian dollar (AUD).

The study also highlighted that many populists drift away from their more extreme positions when in office towards the center ground, helping to calm any market jitters in the process. Beyond this, populist movements tend to pass, when a more conventional political party or candidate assumes power once more.

Businesses can protect themselves with a six-point FX risk strategy

No company can eliminate FX risk completely, but you can certainly minimize it. A thorough approach includes the following:

  1. Measuring your FX exposure in each currency by volume

  2. Identifying what business areas are at risk

  3. Using rich data including historical FX data to inform your decisions

  4. Defining your minimum acceptable FX rates in each currency pair you are exposed to as well as your preferred target levels at which to transact

  5. Keeping your FX product arsenal as simple as possible, with the strategic use of spot and forward contracts to optimize FX rates

  6. Keeping abreast of current economic affairs and carrying out periodic reviews of your FX strategy

Populism can provide some upside to your currency exposure, but in general, it provokes significant investor uncertainty, as witnessed this year with the TRY. In the current global climate, should your company be exposed to emerging or commodity markets in particular, a solid FX strategy to protect against populist-induced FX risk is essential.

Sources

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