Is The Euro Expected To Strengthen Following 2016-17 Election Season?

Hailed as the world's second reserve currency, the euro (EUR) serves as official legal tender to the European Union (EU). Since its introduction in 1999, the institution of the euro has been a hotly debated topic. Advocates cite potential benefits such as limited transaction costs, managed inflation and low interest rates as reasons for its implementation. Opponents contend that the euro promotes a loss of national sovereignty for EU members, primarily through the excessive monetary authority granted to the European Central Bank (ECB).

This ongoing debate has become an integral part of the political dialogue throughout the EU. Elections taking place in France, Germany and the Netherlands are scheduled for 2017 and will define the future of the EU for years to come. As a result, the euro is likely to experience periods of enhanced volatility, either enforcing or questioning its role as a dominant world currency.

The Election Season Of 2016/17: Strength And Weakness

The election season of 2016 brought several historic surprises, which in turn greatly influenced the valuations of many global currencies. Unexpected results from the U.K.'s Brexit vote in June, followed by the U.S. general election in November, and December's Italian referendum have brought an abundance of uncertainty and volatility to global currency markets.

The reaction by the euro to the outcomes of Brexit and the U.S. general election exhibited its degree of sensitivity to political stimuli. Examination of the market behaviour facing the key pairings of the EUR/USD and the GBP/EUR illustrate the extent of the euro's versatility as well as its role in global currency exchange.

During Brexit, the euro showed strength in comparison to the GBP, providing traders and investors an avenue by which to remain vested in the eurozone. In the immediate aftermath of Brexit, the GBP lost 7% against the euro^[1] as questions regarding the U.K's economic future prompted market participants to shift capital out of the GBP into safer assets.

For the same period, the euro's lagging performance against the USD illustrated the depth of concern over the future of the EU itself. As a product of questions surrounding the long-term sustainability of the EU, the euro lost 2.2% of its value against the USD. Although the fallout from Brexit hit the GBP more severely, a shadow was cast upon the global standing of the euro. If other nations were to support an exit from the EU, what does that mean for the euro? The elections of 2017 are likely to shed some light on the answer.

The election of Donald Trump to the U.S. presidency also proved to be a shock to euro valuations. Strong campaign rhetoric promoting nationalistic themes and U.S. trade reforms brought the future of U.S./EU relations into question. Trump's economic policy towards the EU was likely to impact the annual US$699 billion in two-way trade, fundamentally changing the relationship.

In turn, the euro reacted chaotically. A strong initial rally in the EUR/USD gave way to an intense sell-off, producing a test of yearly lows. By the middle of November 2016, the euro had posted its longest losing streak ever against the USD.

2016 was a historical year for euro valuations. While appreciating some 14% against the GBP year-over-year, losses of 3% were realised against the USD. The possibility of a potential change in the economic health of the eurozone and future validity of the EU as a governing body were major causes of the market tumult.

Election Season Of 2016/17: Future Value Of The Euro

The weakness shown by the EUR/USD in the aftermath of 2016's elections, coupled with Europe's full 2017 electoral calendar, have many analysts and currency experts calling for a challenging year. One prominent investment bank has even called for the EUR to be trading at parity with the USD—a level not seen since the early days of the euro—by the end of 2017.

However, a contrarian case is being made that the euro will show strength in the coming months. There are several reasons cited for the move, including growing euro-area inflation (1.1% for December 2016), subsiding political uncertainty and future action by the U.S. Federal Reserve being already accounted for in euro pricing. No matter which point of view is being championed, the euro's relative strength depends upon the economic well-being of the eurozone and the future existence of the EU.

Summary: Electoral Outlook For 2017

While the future value of the euro remains a bit of a mystery, the nations of the EU have a full electoral calendar for 2017. Listed below are several elections that have the potential to shake up markets and increase volatilities facing the euro:

• Netherlands general election: 15 March 2017
• United Kingdom local elections: 4 May 2017
• French presidential election: 23 April and 7 May 2017
• Germany federal election: 22 October 2017

The unexpected outcomes of the Brexit vote, U.S. Presidential election and Italian referendum have been largely attributed to a widespread shift towards populist and nationalistic ideals. The relative strength of this movement will impact the coming elections of 2017.

Undoubtedly, currency traders and investors alike will be monitoring international politics with an even greater attentiveness than in 2016.

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