A funny old day
It’s been a funny old reaction in markets to this election result. Arguably the reaction has not been as extreme as the result. The multi-faceted effect of a minority government on Brexit, business confidence, the deficit, interest rates, the country’s credit rating and populism, to name just a few, means there is wide range of interpretations from investors. The UK has been left with a hung parliament and PM Theresa May never got her ‘stronger mandate’ for the Brexit negotiations. In many ways a hung parliament is the least market-friendly result because it creates uncertainty and could be the biggest delay to the start of Brexit negotiations.
Global markets shrug
The British pound slumped when the main exit poll was released and never really recovered. Although the pound fell, the FTSE 100 as well as other global indices opened higher on election result day. Traditional havens like gold and the Japanese yen dropped as global markets shook off the result as a UK-only affair.
In terms of importance this week, the ECB and The Donald probably rank higher than the UK election result. Donald Trump looks like he will avoid efforts to impeach him for now (as we suspected). Former FBI Director Comey’s testimony to congress was all snipe and no evidence. The euro fell after the ECB meeting last week; we still think the ECB is on a road to signal tapering but it is being done at glacial speed. That could mean downside risk for the euro over the next few weeks.
Brexit – what now?
Theresa May hasn’t achieved her goal of a bigger mandate for Brexit and that creates uncertainty.
We see two near opposite scenarios for Brexit as a result of the election. That goes some way to explain the relatively muted reaction in sterling compared to the day after the referendum. May can soften her Brexit approach in hopes of opposition party support or harden the approach in order to ensure support from EU sceptics within her own party. For one, we think the chance of a parliamentary vote at the end of the negotiations overturning a Brexit deal has increased substantially.
One of the more fervent Leave supporters in the EU referendum, Brexit minister David Davis suggested in the early hours on Friday that the government’s position on membership of the single market should be reconsidered. To us, aggressive posturing from Europe would suggest a ‘Soft Brexit’ whereby concessions on immigration can be met with concessions on the single market is basically impossible whichever UK political party is involved.
Welcome back FTSE dip buyers
On a day that the most business-friendly party lost its majority, the FTSE 100 was the best performing equity benchmark in Europe. The more domestically-focused FTSE 250 felt the brunt of the limited investor backlash. The British stock market managed to capture both the elements of uncertainty and a weaker pound all in one day. We understood the strong currency-influence on the FTSE 100 coupled with the global bull market meant downside could be limited. But we were surprised with the quickness of the turnaround. Indeed only futures traders knew the FTSE had turned lower since the cash market opened in positive territory. Equity dip-buying is still the only game in town.
The drop in the pound has proven negative for domestically-focused retailer and homebuilder shares and a positive for firms reliant on foreign earnings like Burberry (LON:BRBY) as well as multinationals like oil and mining companies. Banks shares were amongst the worst performers, despite the positive implications for foreign earnings because it likely means a longer wait until the Bank of England raises rates.
The pound reaction
Once the dust settles and the shock is absorbed, we think the negative reaction in Sterling and gilt markets can be dispersed. The traditional assumption of market-friendly Conservative Party policies should be an overall positive on UK asset prices. Just less so within a minority government. We assume a Labour victory would have been much more sterling-negative, perhaps GBPUSD back towards 1.25.
A hung parliament
The Liberal Democrats leader Tim Farron has ruled out a coalition with May’s Conservatives so the Prime Minister will try to go it alone with what looks like unofficial help from the DUP. May could have quit so there is relief at some sense of continuation and no ‘coalition of chaos’ between Labour and the Scottish National Party. Looking at a broader outlook for British politics, Jeremy Corby’s left-wing agenda exceed all expectations but the youth vote alone is not enough to win an election so Labour still lacks wider acceptance from the British public.
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