The pound has plunged, but the FTSE has rallied, following the result of the UK general election which yielded another unexpected result of a hung parliament.
With further financial market volatility on the horizon, asset managers have been sharing their view on Theresa May’s disastrous election campaign that was designed to bring her a greater majority, yet resulted in a hung parliament result.
Now with the Conservatives now relying on Northern Ireland’s Democratic Unionist Party (DUP) for its support to create a government and many calling for Theresa May to resign, rather than the stability she hoped for, more uncertainty has been created around Brexit.
Various EU officials have spoken out earlier today, predicting a delay to the Brexit, talks amid such UK government instability.
Sterling’s value dropped overnight and stood 2% lower at about US$1.27 as trading began. Against the Euro it dropped by 1.7% at 1.1350. Yet, shares were higher with the benchmark FTSE 100 index up at 0.9% at 7,515.31 this morning.
The financial services industry has reacted with shock at the result, with many asset managers factoring in an increased Theresa May majority into their portfolios.
David Zahn, head of European Fixed Income at Franklin Templeton Fixed Income Group, noted that May’s gamble didn’t pay off.
“She had hoped that a resounding election victory and an increased majority in the House of Commons would give her a mandate to pursue her own political agenda and, in particular, strengthen her hand in negotiations to secure the United Kingdom’s withdrawal from the European Union (EU).
“But those plans are in tatters and instead, slightly less than a year after the country voted to leave the EU, the United Kingdom has been plunged into further political uncertainty.
“We expect the pound to plummet and gilt yields to decline as investors embark on a so-called flight to safety. Overall, we think so-called risky assets, such as equities, are likely to underperform.”
Richard Colwell, head of UK Equities at Columbia Threadneedle Investments, highlighted that the UK election result “is not what the market expected”, with the contradictory situation of Labour leader Jeremy Corbyn, (pictured left), seen as as a ‘winner’ despite Labour finishing second in the race to 10 Downing Street, with 261 seats.
Conservative leader Theresa May has been seen as a ‘loser’ due to the Conservatives failing to win enough seats to form a majority government, yet the party ‘won’ the most seats with 318, eight short of the 326 needed to form government.
It has been announced that May, (pictured below left), has support of the Northern Ireland’ Democratic Union Party (DUP), which has just ten seats and will aim to join together and form a government together with the slimmest of majorities between them. This is likely to be just three MPs, with one seat left to call, but will see the DUP able to have a greater influence on UK politics than it could have ever expected.
Indeed DUP leader Arlene Foster earlier today said that she expressed doubts that Theresa May can “survive”.
Labour had also said that it is willing to form a minority party government as it believes that it can gain support for its policies across other parties without forming a coalition, although this scenario is unlikely.
What is likely is that a general period of further instability will commence with a possible further general election with the next six months, general seen a s a disaster for Brexit negotiations and financial stability.
Colwell noted that the initial market reaction post the EU referendum and US election proved short-lived.
“A number of stocks that could be vulnerable under a more interventionist government have been weak for some time (eg transport and utilities), so this isn’t coming from a clear blue sky.
“Any sell-off in media and leisure stocks could prompt takeovers. However, if pressure on sterling continues and the currency returns to the lower end of its recent trading range, dollar earnings for multi-nationals listed in the UK will be boosted. Remember the UK stock market is much less reliant on the domestic economy than in previous cycles.”
NO MANDATE FOR HARD BREXIT
Robeco’s chief economist Léon Cornelissen noted that the narrative of May needing a landslide victory to create the maximum room for manoeuver to negotiate the Brexit “has dramatically failed”.
“During the campaign she was pushing for a hard Brexit, especially detailed plans on reigning in immigration, and a lot of nonsense that no deal with the EU would be better than a bad deal, and clearly there is no mandate for it.”
“But this doesn’t make the Brexit negotiations any easier. With a hung parliament it’s difficult to see how they’ll be able to make an upfront deal on the up to £100bn of divorce payments that are being demanded by the EU. What’s most likely now is a coalition between the Conservative and the Ulster Unionists, but it would be an unworkable razor-thin majority. So a collapse of the government is likely, with perhaps new elections in October.”
Saker Nusseibeh, chief executive at Hermes said sterling is expected to come down as “markets abhor both the unexpected and uncertain”.
For Bill Street, head of investment for EMEA at State Street Global Advisors, sterling is already “substantially undervalued” against the dollar and euro, reflecting future uncertainties.
Pioneer Investments’ head of Global Asset Allocation Research, Monica Defend, noted that, since the referendum, the pound has experienced a sharp depreciation, but it has recovered some ground as markets started to discount the possibility of a “soft Brexit” and on the back of economic resilience in the UK.
Salman Ahmed, Chief Investment Strategist, Lombard Odier Investment Managers, comments on the outcome of the 2017 UK General Election:
“UK politics has thrown another electoral surprise as the Conservative party has lost its majority, contrary to the predictions of most pre-election polls.
“The early election gamble from the Conservative prime minister Theresa May seems to have backfired – rather than delivering a stronger mandate for the Conservative party it has resulted in a major setback, both for May’s standing and her party’s position.“We have been highlighting for some time that pre-election polls are unreliable and volatile and that markets remain overly benign in the run-up to elections. Our fears regarding downside risk to Sterling have also been realised, with the pound taking a knock on the prospect of a hung parliament.
“At this stage, it is unclear what the future make-up of UK government might look like and whether we will have another election. This also creates significant uncertainty around Brexit negotiations, including timelines. Given May’s hard Brexit stance, it appears that the change in political support will be read as a desire for a more pragmatic approach to an exit from the EU. That said, the picture remains confusing with no clear support for any specific agenda.
“We think that Sterling will remain under pressure in the days ahead and are watching the 1.25 level carefully as we noted pre-elections. UK equities are likely to fare better, in our view, helped by currency depreciation. However, we believe that upside potential remains capped, especially relative to continental Europe where fundamentals seem to be improving fast alongside a very dovish ECB; continental Europe remains our core value call in the equities space.
“Broadly, we see this election result as having little impact on global risk sentiment and we remain positive on emerging market local currency debt and equities.”
Through the BlackRock Investment Institute, the US financial giant delivered this today’s UK general election result
UK election: Bigger Brexit uncertainty
The UK election resulted in a hung parliament, with no party winning an outright majority in an outcome that will create uncertainty about the path ahead for Brexit negotiations.
This is only the second hung parliament since 1974. The Conservatives look to have won enough seats to form a minority government with some smaller groups. We see a new Conservative leadership race as likely at some point to replace Prime Minister Theresa May, who called the election on hopes of securing a bigger majority for a freer hand in Brexit negotiations.
The winner of that leadership race will shape the UK’s negotiating stance with the European Union (EU) unless a new election is called. A new election is possible but would require two-thirds of parliament to approve.
We see this as a mild short-term negative for UK domestic assets due to the uncertainty and prospect of a weak government vulnerable to losing votes in parliament. We expect the Bank of England to keep its accommodative policies in place to support the economy through the uncertain negotiation period, looking beyond any short-term inflation spikes unless price pressures become sticky.
We see bigger risks of an economically disruptive “no deal” Brexit – one that leaves the UK without existing trade or security agreements by the hard March 30, 2019 deadline. A minority government may be hostage to eurosceptics and others hostile to making concessions to the EU. But we also now see a wider range of potential outcomes, including a softer Brexit in light of parliament’s new makeup.
The pound should remain a good barometer of Brexit risks, we believe. One market positive from the election is the reduced risk of another Scottish independence referendum. We see the election outcome as a UK domestic issue and don’t expect broader ramifications for global markets.
The EU is willing to do a deal, we believe, but wants to draw a clear line between the benefits and responsibilities of members versus non-members. The EU has other priorities.
New French President Emmanuel Macron looks poised to build on his win with a parliamentary majority that may make it easier to pass business-friendly reforms. Macron and German Chancellor Angela Merkel are leading a revived drive to reform the EU, a bigger priority than spending energy haggling over Brexit terms.
The big question is whether an outline agreement can be reached by the hard March 2019 deadline. The main two sticking points: the size of the UK’s exit bill – reported to be €60-100 billion – and a deal on citizens’ rights on both sides, including any ongoing role for the European Court of Justice.
The EU wants to settle these issues before discussing any future relationship. The EU is likely to give the UK some time before beginning any formal discussions, originally scheduled for later this month. We believe the UK’s uncertain political outlook means the timetable for reaching an agreement is even more compressed, with the clock already ticking.
Adrian Hull, Senior Fixed Income Investment Specialist at Kames Capital, said:“Not a natural gambler, May’s snap election has backfired leaving political uncertainty. There is little doubt her political authority has been reduced and there will be all kinds of conclusions emerging today, most notably around the style of Brexit and her leadership.
“The market reaction to increased uncertainty so far has focused on weaker Sterling but even that looks muted as currency markets seem to interpret a hung Parliament as a softer Brexit. Equally with the Gilt market a touch higher there is not panic here.
“Further Sterling weakening could see weaker domestic growth and higher than forecast inflation. At this point Mark Carney becomes increasingly important; Gilts and global bond markets are at range lows and data continues to make valuations look stretched.
“Today’s electoral wobbles do not change that view. The MPC has looked through “transitory” inflation and worries about consumer demand. With investment at only 15% of GDP and consumption nearer 70% of GDP the consumer remains the barometer for rates policy. Given the central bank’s comments on the squeezed consumer we expect Mr Carney to remain supportive for rates markets but he is no guarantee to Gilts continuing sub 1% in 10years.
“As the politics play out opportunities will emerge; our concern is that fascinating politics may not make for the volatility we would like to see – continuing one of the themes for 2017 so far. This is no 1992 where a surprise election result saw Gilts move higher by 5 points!”