Discussion / Read Chapter 11 / 300 words / need in 20 hours
Now that the US presidential election is over how would you estimate the impact it, and its resolution, on FX rates for the next year and the subsequent impact on MNC’s cash flows?
Forex exchange rates are vital for international trade between individuals, organizations, and governments that do not have a common currency. In today’s free-market economy, forex exchange rates determine a country’s level of trade in international markets. However, FX rates are often affected by political events such as presidential elections, or national referendums. A country’s political state influences its economic performance that, in turn, affects currency strength. Investors prefer directing their financial resources to countries that have little or no risk for political turmoil and instability. As such, the US is an attractive market for foreign investors because the country’s presidential elections are well-organized and peaceful. Research indicates that Republican presidencies trigger a rise in the Dollar’s value within the first year after an election. On the other hand, Democratic presidents often start with a low Dollar value which then increases towards the end of presidential terms, (Ashour et al., 2019).
An increase in the dollar value attracts foreign investors; thus, cash inflows can increase for Multinational Companies in the US. However, Yale Hirsch’s “Presidential Election Cycle Theory” suggests that weak performance in Equities is recorded in the first year after presidential elections. Different presidents often adopt different policies within the first year of being in office. During this time, investors are uncertain about the trade policies that will be implemented (Colón-De-Armas et al., 2017). FX rates fluctuate in the first year after a presidential election creating more uncertainties for foreign investors. Therefore, multinational companies are likely to register a decrease in their cash flows.
When it came to the 2016 U.S. presidential election, most polls predicted that Hillary Clinton would win the election. Her views and proposed policies on international trade and U.S. relations with Mexico were substantially different than the views of President Donald Trump. This is why the peso declined rapidly in value after the election, reflecting increased uncertainty about the future of trade between the U.S. and Mexico.
However, overall, the response from the currency markets has largely been less severe than analysts had initially predicted. This is because Trump gave a surprisingly considered and humble victory speech, imploring the American people to unite and work together.
The US Dollar did collapse against currencies that were considered comparatively safe. This included the Pound (GBP), Euro (EUR), Swiss Franc (CHF) and Japanese Yen (JPY).
MNCs also did not take well to Trump’s hardline approach on trade with China because of all the factories in that region. It changed the nature of their investments, and more went to their domestic interests.
Compared to the known outcome of the US presidential election in the question, an important factor that has to be taken into consideration at the moment is the possibility of election surprises. Election surprises occur when the election result does not match forecasts or previous poll results, and can have a significant impact on exchange rates. For example, within a few days after Trump’s somewhat surprising victory in 2016, which has diverged from results of most opinion polls, the value of the Mexican peso against USD declined dramatically. The depreciation reflected the growing uncertainty and increasing market anxiety over U.S-Mexican trade relations. The Chinese Yuan will likely experience a similar loss if President Trump were elected for a second term.
Even without the element of election surprises, the outcome of the presidential election will affect exchange rates in a slightly longer run depending on the respective monetary, fiscal or even foreign policies of the Republican/Democratic candidate. Given the unpredictable outcome, changing policies under the new administration and the resulting fluctuation in the U.S dollar market, it will not be surprising to see a decrease in MNC’s cash flows which are highly susceptible to exchange rate risk.