UK Election: Clutching defeat from the jaws of victory

With the votes having been counted for 649 of the 650-seats in the House of Commons, the ruling Conservatives have 318 seats, a net loss of 12 seats. Labour, the main opposition party, won 261 (+32).

Even if the Conservatives win the 650th seat, they will at best be 7 seats short of an absolute majority and 5 seats short of a working majority – a hung parliament.

Prime Minister Theresa May announced that the Conservatives would form an informal alliance with the Northern Irish DUP which won 10 seats. The DUP would support the Conservatives in key votes, likely in exchange for some say on government policy.

Theresa May’s future seems secure for now but medium-term I would expect her position to come under close scrutiny and a party-leadership battle remains a distinct possibility.

Sterling has weakened about 1.5% post election, in line with my and market expectations. The Conservatives’ loss of seats raises serious questions about Theresa May’s leadership, her decision to trigger early elections and the risk of a party leadership battle to oust her.

Moreover, markets will likely remain concerned about the shelf-life of a Conservative-DUP alliance and its ability to push legislation through parliament.

However, I also see scope for Sterling’s downturn to fade and even reverse in due course. To be clear, a V-shaped Sterling recovery would likely remain elusive.

Two key questions pertain to the likelihood of this new Conservative-DUP formal alliance 1) securing an advantageous EU deal and 2) opting for a “hard” or “soft” version of Brexit.

If anything, the past two months have reinforced my view that the government is ill-equipped, ill-prepared and lacking in institutional capacity to negotiate complex deals with the EU and non-EU partners.

The composition of parliament and its take on Brexit leave Theresa May in somewhat of a bind. The government may therefore have little choice but to seek support from some of the 322 opposition MPs who on the whole favour the UK remaining in the EU or at the very least a “soft” version of Brexit.

So while I do not expect a second referendum on the UK’s membership of the EU, I do see a possibility of the government toning down its rhetoric and potentially opting for a softer version of Brexit – a development which UK financial markets would welcome in my view.

At the very least, this election has further weakened the idea that nationalist parties in Europe are gaining the upper hand.

Read UK Election: Clutching defeat from the jaws of victory in full.

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UK General Election Scenario Analysis – Impact on Policy, Theresa May and Sterling

In less than 24 hours the British electorate will start voting in the election for the 650-seat House of Commons with the result expected early in the morning of Friday 9th June.

While the last general election was only held two years ago, there is arguably as much if not more at stake this time round than in May 2015.

Opinion polls still point to the ruling Conservatives winning a record-high 44% of the national vote ahead of the opposition Labour Party, but polling agencies which in the past have misestimated true voting intentions still display great inconsistency.

Ultimately it is the number of seats which British parties command which matters and the UK’s first-past-the-post electoral system makes it difficult to predict.

You Gov’s constituency-specific model forecasts the Conservatives winning only 304 seats as a result of a record number of “wasted” votes, a 26-seat loss and well short of both a working and absolute majority. Labour would increase its seat numbers from 229 to 266.

This would result in a hung parliament and either a coalition or minority government.

My own model points to the Conservatives winning around 360 seats (55.4% of total) and Labour 212 seats. Admittedly, this prediction is based on a number of assumptions, namely the net share of votes which Conservatives gain from other parties as well as voter turnout.

Whether the Conservatives significantly improve on their current 330 seats or fail to secure a parliamentary majority remains a tough call and there is an almost infinite number of possible outcomes.

However, I have narrowed down in Figure 10 the number of seats the Conservatives could win to eight possible scenarios, in each case assessing i) Their probability; ii) Their numerical impact on the Conservatives’ majority (or lack thereof); and iii) The risk of opposition parties and/or Conservative backbenchers high-jacking the policy agenda.

Figure 11 assesses for each of the eight scenarios their likely impact on iv) Theresa May’s standing within the Conservative Party and v) Sterling and currency volatility.

Regardless of what happens tomorrow, two events beyond British shores also scheduled for 8th June – the ECB’s policy meeting and Former FBI Director James Comey’s testimony to the Senate Intelligence Committee – will conceivably exacerbate Sterling volatility.

Read ‘UK General Election Scenario Analysis – Impact on Policy, Theresa May and Sterling‘ on my website.

UK Election Special – When Two Tribes Go To War

British voters will on Thursday 8th June vote on the composition of the 650-seat House of Commons – the third major popular vote in two years – after Prime Minister Theresa May’s decision back in April to trigger early general elections.

Theresa May’s motivations were arguably four-fold: (1) Win a popular rather than party mandate, (2) Capitalise on the massive lead in the polls the ruling Conservatives enjoyed over the opposition Labour Party and thus allow her to push through her own agenda, including a possibly softer form of Brexit, (3) Allow the government more time to secure a new EU trade deal, and (4) Strengthen the government’s stance in negotiations with the EU.

Objectives (1) and (3) will likely be met but objectives (2) and (4) may prove more elusive.

Opinion polls point to a trend-fall in popular support for the Conservatives to around 44% and sharp rise for Labour to 35%, with the gap between the two main parties halving to about 9pp from 20pp six weeks ago. Aggregate support for the Liberal Democrats, UKIP, SNP and Green Party is flat-lining around 18%.

However, there is still great discrepancy amongst polling agencies which in the past have misestimated true voting intentions. Moreover the UK’s first-past-the-post electoral system makes it difficult to translate share of votes into seats numbers. Whether the Conservatives significantly improve on their current 330 seats or fail to secure a parliamentary majority, as You Gov currently predicts, is a tough call.

Nevertheless, a number of important themes have emerged in recent months.

First, the slingshot campaign has exposed the frailty and flaws of the Conservative machine, including of its leader and manifesto, and reinforced my view, first set out in December, that the government is ill-equipped, ill-prepared and lacking in institutional capacity to negotiate complex deals with the EU and non-EU partners.

Second, it is a two-horse race between the ruling Conservatives and Labour, with the other parties on course to secure only a modest number of seats – a break with recent elections.

Finally, the political centre of gravity has shifted to the left, with in particular tax rates likely to rise regardless of which party wins next week’s election.

My core scenario is a hollow victory for the Conservatives: 360-370 seats with a low voter turnout. This would reduce the risk of opposition parties and rebel Conservative MPs torpedoing government legislation but would fall short of the landslide victory which Conservatives thought possible back in April.

Finally, a modest (or even significant) increase in the Conservative’s parliamentary majority is unlikely to materially improve the government’s hand when negotiating with the EU.

Read UK Election Special – When Two Tribes Go To War in full on my website.

Asian currencies keeping their head in a world losing its own

Financial markets have had much to digest in recent weeks and the calendar for the remainder of May and June is anything but light, with the Fed and ECB holding key policy meetings and legislative elections in both the UK and France.

Nevertheless, most major currencies have either been flat or appreciated against a slowly weakening Dollar in the past month, with only the high yielding Brazilian Real, Russian Rouble and Indian Rupee (INR) and Australian Dollar weakening by 0.5% or more.

Conversely, European currencies have outperformed, with in particular the Euro Nominal Effective Exchange Rate (NEER) up about 3.4% since mid-April – in line with my constructive near-term euro outlook.

Non-Japan Asian (NJA) NEERs have seen only very modest moves in the past month. Bar the Malaysian Ringgit NEER which is up about 1.1% and the INR NEER which is down about 1.7%, NJA NEERs have appreciated or depreciated by less than 1%.

The question is whether this relative calm in NJA currency markets is likely to become more entrenched or whether FX flows and/or central bank policy are likely to fuel greater volatility or see some currencies adopting a clearer direction.

As a starting point, I would again note that the pace of depreciation and appreciation in most NJA currencies tends to be confined to reasonably narrow ranges.

While this is partly a by-product of seasonal patterns in current account balances and the ebbs and flows in capital migrations, it also arguably reflects central banks’ desire and scope to control their currencies.

At this juncture I would conclude that few central banks – including the MAS and PBoC – face overwhelming economic reasons to markedly alter the paths of their currencies via the bias of FX intervention and/or interest rate policy.

There is however perhaps a case for Bank Negara Malaysia to favour a weaker or at least stable Ringgit NEER which has appreciated about 2.7% since mid-April.

Politics suspected of interfering with economics and markets

In the US, political intrigue, seemingly lifted straight out of a John Le Carré novel, has reached a crescendo and there are now multiple investigations running concurrently.

If we assume these investigations will run over weeks/months, the question is whether and to what extent this political backdrop is likely to impact financial markets, US government policy-making, the US and global economy and Federal Reserve monetary policy.

US equities have corrected lower, volatility has spiked and markets are seemingly ignoring positive data surprises

It has all been rather orderly so far but it is difficult to see how at this juncture, with major policy initiatives likely kicked down the road, US equities can launch another meaningful rally. If anything big data misses are likely to further pressure stocks.

The Dollar’s performance has been mixed in the past month, posting its biggest loss against the euro in line with the fundamentally bullish euro view I expressed in December and April.

Capital inflows into the eurozone allied to a 2% of GDP current account surplus, a pick-up in economic activity and receding political risks following the French presidential elections are likely to extend the euro’s current rally near-term.

However, the ECB’s stance on its quantitative easing program will be key in shaping the euro’s medium-term path.

US economic indicators paint a blurry picture while solid global GDP growth is seemingly struggling to make further gains.

The Fed and US rates market have the unenviable task of making sense of these macro trends and a quickly changing political landscape.

The apolitical Fed will of course stay above the political fray, even if markets do not with pricing for the probability of a 25bp hike at the 14th June policy meeting continuing to oscillate between 60% and 75%.

My core scenario is that the Fed will hike rates only once more in 2017 although I acknowledge that this is not a high conviction call. The market seems still on the fence, pricing in a further 32bp of hikes in the remainder of the year.

Read the full article on my website.

2017 French elections – They think it’s all over…it isn’t

Emmanuel Macron, the centrist founder of the En Marche! movement beat National Front candidate Marine Le Pen by two votes to one in the second and final round of the French presidential elections on 7th May, in line with my core scenario.

But for President-elect Macron (and arguably the other main party leaders), the hard work starts now. Macron is expected to appoint next week his Prime Minister and there has been much speculation.

I would expect Macron to pick a head of government and approve cabinet ministers who will not polarise political opinion. The appointment of a “rainbow government” would likely help his party – recently renamed “La République En Marche” – secure the largest number of deputies at the forthcoming legislative elections on 11th and 18th June.

If his party succeeds as opinion polls suggest – no mean feat for a party which is only a year old and currently has no parliamentary deputies – this would in turn help reinforce Macron’s position and his choice of Prime Minister.

However, polls suggest that La République En Marche may fail to secure a majority of the 577 seats in the National Assembly.

If the party falls well short of that number, it would likely seek a loose coalition with either the Republican Party or less likely with the beleaguered Socialist Party, in my view.

The National Front is likely to cement its position in French politics but it will need to reform itself and I would expect personnel changes and policy tweaks.

Marine Le Pen fell well short of securing the presidency and this should have come as no great surprise as nationalist parties in other EU member states have also come up short.

This is in line with my view that while nationalist/populist parties may have greater influence on the political landscape they will in most cases fail to exercise true power, let alone dismantle the eurozone and/or EU.

Finally, opinion polls which predicted with great accuracy the second and in particular first round of the presidential elections, are back in favour – at least in France.

Read 2017 French elections – They think it’s all over…it isn’t in full on my website.

US, UK and global GDP growth update – Put the champagne on ice

US GDP data weakest of a disappointing lot….

Data released today show that Q1 2017 real GDP growth:

  • In the US slowed to 0.7 quarter-on-quarter (qoq) annualised, from 2.1% qoq in Q4 2016 – the weakest growth rate in three years (see Figure 1);
  • In the UK halved to 0.3% qoq – the weakest growth rate in a year;
  • In France slowed to 0.3% qoq from 0.5% qoq in Q4 2016; and
  • In Spain rose to 0.8% qoq from 0.7% qoq in Q4 2016.
Read the full article on my website.