It was supposed be a UK general election that solidified Conservative dominance, and boosted Brexit leverage. It ended up being the opposite, after British voters delivered a stinging rebuke to Prime Minister Theresa May and her ruling Conservative party, depriving her of a majority, resulting in a "hung parliament" and thrusting the country back into a new period of uncertainty as it prepares to depart from the European Union.
A quick recap of what happened overnight:
- No party managed to get a majority in Thursday's election, resulting in a hung Parliament.
- Theresa May remains prime minister. She could push forward with a minority government, or potentially look to another party such as Northern Ireland's DUP to give her enough support in the lower house, which is what SkyNews is reporting will happen.
- EU officials have said Brexit talks should only begin once a government is in place.
- The pound fell sharply on the exit polls, and remained low overnight, although it has rebounded from the lows..
- Stocks in the biggest U.K. companies jumped when the market opened, on the back of the weaker pound, but have given up some gains.
- May is said to seek to form government, and she won't resign. Sky says she will govern with the support of the Northern Ireland's Democratic Unionist Party, making her a "lame duck."
On the basis of the declared results available early in the session, the Conservative Party won 316 seats (or just about) in the 650 seat Parliament (losing 15 seats), compared with 265 seats for Labour (a gain of 33 seats). These numbers are fluid and continue to change, mostly in Labour's benefit.
A return to a two-party system by vote share
May first called the election in April, betting she could substantially increase her party's majority and strengthen her hand as she negotiated an EU exit. As polls closed, that gambit backfired, and as tallying went on, her party lost rather than gained seats. By early morning, it was clear there would be a so-called hung Parliament, in which no party has command. The surprising blow immediately put Mrs. May's leadership of her party and of the government in question.
The formation of the next government is currently unclear, although a minority Conservative administration appears the most likely outcome. The weaker government implied by such an outcome implies a higher risk premium on UK assets and a lower level of Sterling. Both market implications have already been evident overnight.
According to recent headlines, May has reached an understanding with Northern Ireland's Democratic Unionist Party to form a coalition U.K. Government. After 648 of 650 seats have been counted, May’s Conservatives have won 317 seats and DUP has 10; 326 seats needed for majority.
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And while we await confirmation, here is a handful of sellside strategist opinions on what are the next ahead for the UK:
Nomura International (Jordan Rochester, FX strategist)
- It’s likely the Conservatives have fallen short of a majority or are just on the edge, he writes
- GBP/USD falls but “has not meaningfully continued lower through 1.27 on its initial break through the level”
- Sterling hasn’t fallen to the 1.24 level as surveys had predicted in the event of a hung parliament as it “could simply be a lack of market liquidity but there is also the questions around what this means for Brexit”
- Markets wondering if this delays things or changes the direction, the “latter point involving soft Brexit is that factor that probably has some bids in GBP here”
Citigroup (strategists including Josh O’Byrne)
- It is possible that there will be a delayed reaction with investors waiting on confirmation that the exit polls are correct
- Citigroup sees a “high probability" that Theresa May resigns, triggering a leadership contest
- Some investors may be reluctant to chase the initial response
- “We see this election risk as largely idiosyncratic for GBP, which looks to have further downside if the exit polls are confirmed”
- Look to “buy any further dip in risk currencies, which should take stronger direction from more broadly supportive macro conditions”
Mizuho International (Peter Chatwell, head of rates strategy)
- “This is an uncertainty discount, rather than pricing the fundamentals of a potential leftist shift in the U.K. government, with a softer Brexit stance”
- If the poll does turn out to be accurate, he expects GBP/USD to turn stronger on the session
- If this exit poll solidifies into reality then this market reaction “should be ‘Trumpian’, i.e. on realization of a softer Brexit stance and more fiscally easy outlook, we should be factoring in greater growth and inflation and gilt supply” generating a steeper gilt curve and stronger GBP
Standard Chartered (analysts Sarah Hewin and Nick Verdi)
- A decline in GBP/USD toward 1.24 is the central case over the next 12 hours on a hung parliament where the Conservatives emerge as the biggest party
- While a more conciliatory approach in negotiations with EU might be expected, until the results are more clearly known, political uncertainty will drive further GBP/USD downside
CIBC (Jeremy Stretch, head of G-10 FX strategy)
- “Even if the Conservatives cling onto Downing Street, their room for manoeuvre, including promoting a hard Brexit, premised on the primacy of immigration over all other considerations, needs to be kept in context”
- “Whatever happens tonight one thing that does not change is that face-to-face EU Brexit talks are due to start on June 19. Who will be leading the U.K. delegation and importantly what view will they be pursuing?”
- “The two-year countdown keeps ticking despite what occurs in the U.K.”
City Index (Kathleen Brooks, EMEA research director)
- While the hung parliament result was a shock, the market reaction has also “been somewhat puzzling”
- After the initial decline, “as the results have rolled in and confirmed the exit poll result, the pound has remained relatively stable, suggesting that the prospect of a hung parliament and a second vote is not triggering market panic”
- Perhaps the market is looking at this result as a vote for a softer Brexit, which could boost the pound in the long run. However, this is fairly presumptuous of the FX market at this early stage
Oanda (Craig Erlam, senior market analyst at Oanda)
- Sterling has fallen off a cliff after the initial exit poll; a hung parliament is worst outcome from a markets perspective as it creates another layer of uncertainty ahead of Brexit negotiations and chips away at what is already a short timeline to secure a deal for Britain
CMC Markets (Michael Hewson, chief market analyst at CMC Markets)
- Plunge in the pound, prospect that Tories could struggle to form majority government is likely to have significant consequences for start of Brexit talks and raise serious questions as to how long May can survive as party leader, let alone Prime Minister
IG (Chris Beauchamp, chief market analyst)
- It has been a fascinating night, more so for the political ramifications than for the reaction on markets. After the initial shock of the exit poll, we have seen both the FTSE 100 and sterling stabilise
- Clearly, the fact that the Conservatives will be able to get past the 326 line with the help of Northern Ireland’s DUP is probably allowing markets, at least at this early stage, to keep a sense of perspective. Had the result been closer, investors would have been more nervous, but it still looks unlikely that Jeremy Corbyn will get anywhere near No. 10
Market Securities, (Stephane Ekolo, chief European strategist)
- “A hung parliament is not good for markets, but the worst possible outcome, which would have been a Corbyn victory, has been avoided. The odds of a U-turn on Brexit are clearly rising. A strong Labour victory would have had a big impact on a number of sectors such as utilities, but with this results, it’s a bit ‘business as usual’ for the equity market, and we should see the FTSE 100 further outperforming the FTSE 250”
Credit Suisse (Pierre Bose, head of European strategy)
- “For FTSE 100, in the first instance a hung parliament will weigh on risk sentiment but in the medium-term slightly weakened sterling is positive for large cap companies. Spillover effect to global markets has been limited, no reason why that has to change”
ETF Securities (James Butterfill, head of research and investment strategy)
- “Typically a weak pound is positive for the index due to their near 70% foreign revenue exposure. FTSE 250 is much more vulnerable to a sell off as it is much more domestically focussed, although exporters could rally on weak GBP. Market worries will primarily be expressed in currencies, creating even more volatility”
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And here is Bloomberg's Richard Cudmore putting it all together
Damage to Sterling Fundamentals Only Marginal: Macro View
The long-term macro fundamentals for sterling were already very negative before this election. The critical issue from the vote is how it might shift the Brexit situation. And ultimately, that dynamic probably hasn’t changed too much. We’re in a sweet spot of uncertainty for the U.K. How long will Theresa May survive as the Conservative Party leader? What does this result mean for Brexit negotiations? All the "noise" will weigh on sterling in the short-term but have the fundamentals really shifted that much? No.
Many investors will claim that, far from a strengthened mandate, whatever government represents the U.K. will now have reduced credibility when negotiating Brexit terms. That sounds bad, but it’s important to remember that the U.K. didn’t have much credibility in the negotiations to start with. The EU always held the upper hand. This doesn’t have to mean a hard Brexit, like some believe, as early rhetoric from both sides of the divorce deal shouldn’t be over-weighted in the context of a two-year (minimum) process. Some investors may even try to suggest the election result makes a soft Brexit more likely.
I would argue that none of the Brexit probabilities have materially shifted. The EU doesn’t want to let the U.K. be a clear winner from leaving the union, but it’s also not in its interests for the U.K. economy to suffer inordinately as it would have negative contagion on interlinked European countries. Some sort of compromise on terms largely dictated by the EU was always likely, with a viable risk of no deal at all. The U.K. was never going to be allowed to cherry-pick terms and win a visibly large victory from the Brexit deal. And that will be the same next week in the wake of this election.
Sterling has an extremely negative real yield, backed by a structural current-account deficit and an uncertain trade status with its closest trade partners. The currency’s future remains bleak due to those factors, which are unaltered by the election. The larger downtrend in the pound started on May 10 and will persist. In the short-term, gilts may not like the election outcome, and sterling can suffer more amid the political noise, but those aren’t sustainable drivers of weakness. They are poor risk-reward reasons for short positions as we can expect two-way volatility in the days ahead.
Be negative on the pound, just not specifically because of the election