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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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Time for putting one's neck on the block ...... or even better, letting someone else do it. ref :- "Pound Is Seen Losing the Most if UK Vote Delivers No Winner" , Bloomberg Markets

June 7, 2017

 

 

Time for putting one's neck on the block ...... or even better, letting someone else do it.

 

ref :- "Pound Is Seen Losing the Most if UK Vote Delivers No Winner" , Bloomberg Markets

 

Traders must approach elections with mixed emotions .... obviously, there are often sizeable profits to be made if you call it right AND the markets react the way you'd expect them to, which is not always a given. If you read it wrong .... well, that can be very painful. That of course is the trader's lot on a daily basis, it's just that elections have the habit (or at the very least, the potential) of magnifying things for better or for worse.

 

Banks and larger financial institutions tend to steer clear of making too many public projections about their take on likely election results  --  there's a danger of betraying a highly inappropriate political bias of their own, not to mention just plain getting it wrong. Some of them do however offer their view of how the markets would respond to a variety of different outcomes. Naturally, one could argue that here too they're offering themselves as hostages to fortune, but at least it has pretty good PR value if you get it right.

 

Yesterday, there was some discussion on Bloomberg and elsewhere about what might happen to UK Gilts given a range of differing outcomes in tomorrow's UK election. You wouldn't imagine that anyone would have felt the need for such a spread of possible results when the election was first called, such was the size of the Conservative lead in the polls at that time. Now that the gap has narrowed so dramatically (some might say as a result of a feeble Conservative campaign that amongst other things has failed to bring any focus onto the key issue at most elections  --  the economy) , virtually any scenario is possible.

 

Anyway, Deutsche Bank gave us their interpretations of where the 10yr Gilt Yield will be in September under all the political regimes that might emerge from the election. Noting that the current yield as we write is 0.99%  --  and of course remembering that as yields rise, prices fall and vice versa  -- they are :

 

Increased Conservative Majority   :   1.25%

Smaller Conservative Majority      :   0.90%

Conservative Minority Coalition    :   1.00%

Labour Minority Coalition              :   1.50%

Labour Majority                            :   1.70%

 

Just taking the lowest and highest prognostications, we can assume that a lower yield in the event of a smaller Tory majority is based on the perception that Tory Euro-sceptics would still play a big hand in Brexit negotiations, which would lead to a harder Brexit, which would lead to a weaker economy. At the other end of the scale, an outright win for an anti-austerity Labour Party embracing nationalisation would see hugely increased government spending and a consequent increase in Gilt issuance.

 

You could conceivably argue that an electoral win for an old-fashioned, hard-left socialist party might mean that a 70 basis point rise in Gilt yields would be the least of your economic concerns, but that's not really the point .... it's a view and a pausible one.

 

Today it's the turn of the Foreign Exchange gurus, and Bloomberg gives us a quick and not particularly broad survey of 11 banks and brokerages. If you access the Bloomberg article, you'll see the full dot-plot, but we'll just take the MEDIAN estimate of the prospects for £ / US$ in the wake of four possible outcomes. The most striking point is that, as Bloomberg point out, not many agree with PM Theresa May's assertion that when it comes to Brexit, "no deal is better than a bad deal". Still, we'll get to that. £ / $ is trading at $1.2900 as we write, and those median estimates are :

 

Conservative Win (Large Majority)      :   $1.3100

Conservative Win (Small Majority(      :   $1.3025

Hung Parliament                               :   $1.2350

Labour Win                                       :   $1.2484

 

What's the thinking behind those calls ?

 

Con Win (large majority)   --  despite the narrowing in the polls, a Tory victory is still already priced in to the market which makes upside potential limited. Nevertheless, markets tend to believe that Tories are on balance better for the economy and one respondent sees cable up to $1.3300 should they have a noticeably increased majority.

 

Con Win (small majority)  --  Seemed unlikely at the start but now probably an outcome as likely as any with the Tory lead slipping sharply. Not expected to hurt the pound as investors would be likely to wait for Brexit negotiations to start before taking their new view on £ / $.

 

Hung Parliament  --  Deemed to be the worst possible result for sterling as it would not only leave the nature of the next UK government in limbo, but could complicate and delay the start of Brexit negotiations. The lowest estimate in the event of a hung parliament is $1.20

 

Labour Win  --  Generally, a Labour victory is held to be bad for sterling but looking longer-term some thought that with the prospect of a softer Brexit and higher fiscal spending (and therefore rates) it might actually be supportive of the currency. Frankly, an outright Labour win is unlikely, to say the least, but a coalition with the Liberal Democrats (and even the Scottish Nationalists) is a possibility.

 

One note of caution ..... a minor pinch of salt should be taken with most of these pre-election predictions. A forecaster can be absolutely correct in choosing the direction of market moves, but the size of them is always something of a guess. Perhaps even more importantly, you've got to be very careful about timescales with these things. Immediate reactions, though eminently logical, may not last for long. Or, on a six month timescale, take the US election as an example :

 

With US 10yr Treasuries yielding 1.85% on election day, in the unlikely event of a Trump win (for so it was considered at the time) most could have predicted that his reflationary, tax-cutting, fiscally stimulative plans would send yields sharply higher, and indeed they rose to above 2.60%. Few would have foreseen that an apparent inability to get things done as the President brawls with legislators, officials and the media would cause that yield to fall back to 2.15%. 

 

Which just goes to show that in the real world, what you think you're voting for is not always what you get.

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