STerling stabilises as doubts cast on new poll

The pound had a hefty sell off late last night after research by the Times newspaper and YouGov suggested that there could be a hung parliament. GBP/USD fell to a low of 1.2788, just above last week’s low at 1.2776, a break below this level is considered a cliff edge for sterling that could eradicate all of the gains made since Theresa May called the election on April 18^th.

Why the markets may look through noisy polls

In short, we doubt that the Times/ YouGov research is giving us the true picture about how many seats each party will win on June 8^th. It predicts that the Tories will win 310 seats, 16 short of the 326 needed to win a majority. However, this was not a poll, rather it is the outcome of a model that has used untested methodology to come up with this hung parliament conclusion. Other polls are predicting a completely different outcome, so we would use this information with a pinch of salt.

However, we do remember that back in November 2016 only one poll from the LA Times predicted that Donald Trump would win the US Presidential election, so we won’t discount the prospect of a hung parliament completely.

Markets adjust to a less certain UK election outcome

One thing is for sure, the direction of this election is shifting. Whereas a few weeks ago Theresa May was predicted to win a majority of some 200 seats, even more than Margaret Thatcher, that lead has been whittled away to virtually nothing. Although we continue to think that the Conservatives will win, we doubt that it will do so by a landslide. My own very small, far from empirical, and unscientific polling of mostly friends and family, suggests that even hard-core Conservative voters have been put off by the May campaign and may choose to abstain from voting altogether; if this is replicated across the country then it could hurt the Tories on June 8^th.

Potential election outcomes and the market impact:

From a markets perspective, it is worth looking through the noise of the polls, there will be plenty of others before Election Day, and unless they start to put Labour in the lead then we think GBP/USD could trade in a range between 1.2750-1.30 ahead of June 8th. There are a couple of scenarios that we are now considering:

1, Big majority for Conservatives (seems unlikely) – this could drive GBP/USD above 1.30, and lead to fresh record highs for the FTSE 100 as it would eradicate the threat of Labour corporation tax increases.

2, Conservative win with a slim majority (seems likely) – this could initially take the wind out of cable, and it could put a lid on the prospect of GBP/USD getting back above 1.30. We think there is a chance of a deeper sell off back towards 1.20 if it looks like Theresa May won’t have a big enough mandate to agree a trade deal with the UK. The prospect of no deal from the Brexit negotiations has spooked investors and may continue to do so after this election. This could weigh on sterling and the broader FTSE 350 index.

3, Hung Parliament (slim chance) - This outcome is the tail risk that the markets have not been expecting, and thus would have the biggest impact on UK asset prices. We would expect the political uncertainty that could arise from a hung parliament and a potential change in leadership would weigh heavily on the pound and the FTSE 100. We continue to think that there is more scope for further downside in the FTSE 100 rather than the pound where there is a sizeable short position, even if it has been reduced in reduced in recent weeks.

Why UK stocks could be vulnerable:

The UK election and the flattening of the US yield curve could weigh on the FTSE 100 today, even though the futures market is predicting a slightly higher open for the UK index.  On Tuesday US bank shares were the weakest performer on the Dow, with Goldman Sachs and JP Morgan the weakest performers in the entire index. This was caused by a further flattening of the US yield curve, which makes it hard for the banking sector, especially the retail banking sector, to make money from lending in the future. We have tended to see UK and US banking stocks move relatively closely, which may put UK banks at risk from a sell off on Wednesday.

China data and EUR also worth considering

Elsewhere, solid Chinese PMI data failed to help the Aussie dollar overnight, and Asian equities were mostly lower as global stock markets took their lead from the US. The euro sell-off seems to have found a bottom around 1.1110. Today’s Eurozone CPI and unemployment data could help boost EUR/USD back above 1.12 if we get some good numbers. There are also some rumours that the Eurozone staff forecasts could be upgraded in time for its meeting next week, also on June 8^th, which may propel this pair higher. A break of the 1.1268 high cannot be ruled out.