In this article I look at some of the ramifications of the upcoming UK election for financial markets. This is likely to be a less volatile event than Brexit.
If the Conservatives don’t get a 50-seat majority, there is downside for the pound. But it would take a shock result to eject GBPUSD from its recent range.
It must be said that the last few days have been a struggle following on from the terror attacks in Manchester and London. Such events seem to affect me much more these days.
More than ever in the last couple of years, I am increasingly frustrated and being drawn into political discussions even though I do not really want them to form much part of this blog.
This last event is particularly disturbing on a personal level as it occurred in an area that I love and outside one of my favourite pubs.
Nevertheless it is time to move on and lets do so by looking at some ramifications of the UK general election which is now upon us.
General Election Predictions
The first thing that must be said about this election and the possible ramifications for financial markets is that this event is not likely to be a major market mover like Brexit was.
The British pound cratered 13% after the surprise Brexit vote and we cannot expect to see such volatility this time around.
However, there will be strong moves for traders to capitalise on and these moves will be intensified further if we get a surprise result.
The first inkling of what to expect should come shortly after 10pm GMT when the official exit poll is published. Historically, this has been a reliable poll and is likely to have a big effect on currency markets while stock and bond markets will be closed.
What’s Priced In?
With the FTSE 100 trading just lower than all-time highs, 10-year gilt yields at 0.98% and with GBPUSD hovering around $1.29, financial markets are currently pricing in a conservative majority victory with an implied chance of around 85% according to Betfair market odds of 2/11 (1.19).
These odds are slightly lower than where they were a week ago but higher than when the election was first called, where the market probabilities of a conservative majority traded at almost 95%.
These probabilities have fallen following a mistake-ridden campaign from Theresa May and surging momentum for Labour under Jeremy Corbyn, particularly among younger voters.
However, support for Corbyn has drifted out once more following the recent terrorist attacks. These events are likely to drive support for Theresa May, seen by many as the leader who would take a tougher stance against terrorism.
Ironically, a labour government under Mr Corbyn would have been more opposed to military invention in the Middle East therefore recent terrorist attacks actually work against terrorist motives. That is of course assuming they have any political motive, which is not clear by any means.
As it stands, markets appear to be pricing in a Conservative majority of between 40 and 70 seats. Such an event would likely lead to a mild relief rally of one or two percent in the pound and probably a similar rise in the FTSE too.
Such a rally may be short lived, though, as investors re-assess the implications of Brexit after the election result is in.
However, given the closeness of the polls, the chance of a shock win for Labour or a hung parliament also cannot be overlooked.
A Shock Result
If the Conservatives are not able to cling to a 50-seat majority, there is likely to be some downside for the pound. But it would likely take a shock result to eject GBPUSD from its recent trading range. ING analysts suggest that the pound could drop to around $1.25 if Labour win.
Such a scenario, or hung parliament, would cause greater uncertainty (particularly around Brexit terms) and this would lead to a negative reaction from financial markets.
However, this reaction is likely to be fairly short-term particularly in stocks which would benefit from a lower pound anyway.
The Big Unknown
The one unknown in all this is the young vote with experts unable to predict how many will come out to vote in favour of the Labour party. There has been huge support for Corbyn from younger people but the question still remains as to whether enough of them registered to vote or will turn up to vote on the day.
Even so, this is a major unknown that could contribute to more volatility on the day and bring a surprise result.
Where To Trade?
Considering the way markets are priced, there does not appear to be any easy trade available.
If the conservatives fail to get a large majority, the pound is likely to come under pressure but a landslide victory would see the reverse. A landslide victory is more likely following the recent terrorist attacks, however, the unknown factor contained within the younger voter makes it difficult to predict.
The best opportunity may well be to wait for the exit poll results and attempt to trade the momentum shown from the markets. Of course, this will be difficult so a solid trading plan will be needed.
One possible strategy might be to look to buy the FTSE on dips. A victory for the Tories is likely to see a relief rally in stocks and see shares continue on their upward trend.
However, a Labour win shouldn’t hurt stocks too much either. Any selloff is likely to be short lived given the global nature of FTSE 100 companies and the fact many also benefit from a drop in the pound.
Where To Bet?
Before the election campaigns heated up I placed a tentative bet on Jeremy Corbyn to be the next PM getting odds of 20/1 on Betfair. Those odds moved in to 5/1 but have now drifted back out to 7/1 implying a probability of around 12.5%.
This seems a little on the low side but we must also remember the recent trend has been for voters moving towards the right, not left. Thus, a win for Corbyn appears unlikely.
A better bet might be found by looking at numbers of seats or at individual constituencies.
Betfair analyst Neil Monnery suggests that Don Valley at 13/8 for a Tory victory is good value based on the logic that Theresa May would not be campaigning there so hard if she didn’t believe it was a very winnable seat.
Another bet to take on is Bradford South, currently 11/4 for a Tory win. Bradford has also seen canvassing from May and is a typically multi-cultural area that could lean towards Tory policies on terrorism and immigration.
I have taken a small bet and will watch the UK markets accordingly. It promises to be another eventful night ahead.
Thank You For Reading
Joe Marwood is an independent trader and the founder of Decoding Markets. He worked as a professional futures trader and has a passion for investing and building mechanical trading strategies. If you are interested in more quantitative trading strategies, investing ideas and tutorials make sure to check out our program Marwood Research.
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