2015 Election scenarios and how the markets will react

The 2015 general election will drive a huge amount of uncertainty in the markets on the simple fact that with the polls too close to call, no one can be certain who will win on May 7th. For one party to win a majority, they require at least 326 MPs to be elected. Current polling has both the Conservatives and Labour party on around 34% of the vote, which is expected to give them between 270 and 290 MPs, leaving them short of a majority. This means – according to the polls at least – that the one certainty is that no party will win a majority.

Election trading scenarios

There are a number of scenarios which could play out and each will have a significant knock-on effect on a number of markets, including the GBP, FTSE 100 and UK Gilts.

So what are the scenarios, how likely are they and how will the markets react to each one?

No overall majority

This is an odds-on certainty, given existing polling shows it is highly unlikely for any major party to win the required 326 seats needed to form a government. In fact, most betting houses have ‘no overall majority’ at 1/10 right now, showing how confident they are this will happen.

This then would leave each major party to negotiate a coalition that would give them the required 326 seats to form a government. Should no party manage to negotiate successfully then the picture becomes more clouded. The leading party by seats could try to form a minority government, but would need to pass its first budget or it will face a ‘no confidence’ vote.

How will the market react?

The market is fairly attuned to the idea that no major party will win a majority of the vote. I don’t think we will get as far down the line as a minority government. There are two obvious scenarios which will likely happen; a Tory and Lib Dem coalition or a partnership between Labour and the SNP.

However, the potential for a sell-off is dependent on the length of time and nature of a negotiation process with a coalition. The longer it takes, the more I expect the GBP and FTSE to face significant pressure whilst UK bond yields could rise as uncertainty grips. Of course, the situation would almost certainly be exacerbated should one party attempt to form a minority government, given the lack of transparency over whether its fiscal budget could pass or not.

Odds on no major party winning a majority: 1/10

Conservative majority government

For there to be a Conservative majority, they need to be polling much higher than the 34% they currently are to get the required 326 seats (they need to be polling at 40% or higher). For example, in 2010 they polled at 36% and won 307 seats, which was still short of the magic number and needed the Lib Dem’s 56 seats to get over the line. As such, this scenario seems quite unlikely right now.

However, as we saw with the Scottish Independence vote, many voters claimed they were going to vote for independence but never actually did. So there remains an on-going debate as to the accuracy of polling data in the run up to Election Day.

How will the market react?

I believe the market would react favourably to a Conservative government. The party is seen as pro-business compared to Labour and maintains the strongest vote of confidence in terms of tackling the budget deficit, returning the UK to a surplus in 2017/18 and bringing consistency to UK economic growth. The only questionable element is the Conservative’s aim to have a referendum on EU membership by 2017. Most of UK businesses are against leaving the EU but considering this policy has been well known and thus digested for some time, it shouldn’t impact market confidence with a Tory victory.

I would expect the GBP and FTSE 100 to both strengthen on a Conservative win, and UK gilt yields to fall.

Odds on a Conservative majority: 10/1

Labour majority government

As with a Conservative majority, this still remains unlikely because the Labour vote is set to be decimated in Scotland, where it currently has 40 MPs. The SNP is expected to win close to 50 seats, a rise from just 6 in 2010 and Labour could lose as many as 30 MPs there. I expect at current polling numbers Labour to win around 280-290 seats. Due to the makeup of constituency boundaries Labour could win more seats with a smaller share of the vote than the Conservatives, but the maths dictates a Labour majority as quite unlikely at this stage.

How will the market react?

The market lacks confidence in a Labour majority government and the last Labour government remains fresh in the memory. Traders are not convinced of Ed Balls as Chancellor of the Exchequer, particularly given he was a member of the Treasury during the last Labour government which almost bankrupted the UK. The attack on banker bonuses and curbs on investment banking, risk-taking and other measures to keep the city in check could also be seen as aggressively worse than what’s currently in place. Moves to invest in public services, decrease austerity and heighten taxation for the top rate payers could all hurt money flowing into the UK and escalate borrowing.

As such, we could see selling out of banking stocks, particularly those that hold UK bonds as a knock on effect of bond yields rallying i.e. the cost to service UK debt. There would also be question marks over infrastructure spending in the North Sea to boost output by oil firms based there, which could hit UK energy stocks. Both financial and energy firms carry a large weighting on the FTSE 100, would suffer if there is selling in these two sectors.

The only positive this would bring for the markets would be a certainty that under Labour, the UK will not leave the EU. This level of certainty will be welcomed by investors.

Odds on a Labour majority: 13/1

Conservative & Liberal Democrat coalition

With the Conservatives unlikely to get a majority, this would force them to seek a coalition. I think this would be one of the best scenarios for the markets. It would be a maintenance of the existing status quo (better the devil you know), and the inclusion of the Lib Dems would force the Conservatives to adopt a more pro-EU stance in the run up to a 2017 referendum on staying in the EU.

The real question is how many of the Liberal Democrats existing 56 MPs will keep hold of their seats. It’s worth remembering that the Lib Dem’s won 57 seats with a 23% share of the vote in 2010. Right now, they are polling at just 8% of the vote. So it’s safe to assume that the Lib Dems won’t win anywhere near as many seats this time around. There is also the fact that the Lib Dem support has been cut monumentally due to their weak role within the last coalition and the party is likely to try and distance themselves from the Tories in an effort to recover in the 2020 election. There is significant antipathy within the party itself towards another coalition with the Conservatives.

Assuming the Conservatives win around 270 seats, they may need as many as 60 MPs to form a majority. As such, unless the Conservatives and Lib Dems both start to garner more support, a coalition between the Conservatives and Lib Dems is unlikely. They will need someone else to join the party.

Odds on a Conservative | Liberal Democrat coalition: 9/1

Conservative & UKIP coalition

A purely Tory and UKIP coalition simply won’t happen due to the lack of MPs UKIP will get seated this election, but there is a potential for UKIP to silently vote for Tory policies as a sleeping third partner within a coalition of the Conservatives and another party, like the Lib Dems. Even though UKIP are polling at 16% of the vote, the chances are they will only win 4-7 MPs.

A UKIP alliance with the Conservatives would be highly dangerous to the markets given any reliance will force the EU abandonment issue and potentially alienate the UK from the EU negotiating table due to the EU’s poor relationship with Nigel Farage.

Odds on a Conservative | UKIP coalition: 20/1

Labour & SNP coalition

With SNP stealing a number of Labour’s seats north of the border, the maths and the fact both parties reside on the left hand side of the ideological scale, I feel this is the most likely scenario.

Labour could win as many as 290 seats, meaning they would need to find an additional 36 seats somewhere. A coalition with the Conservatives is out of the question and the chances are the SNP would become the third largest party with around 50 seats. So clearly a combination here – barring a stronger than expected showing for the Lib Dems – would be the most natural coalition.

Now whilst Nicola Sturgeon has applied pressure on Miliband to combine the two parties in a formal coalition to oust David Cameron, Miliband has so far declined, at least publicly. There is a rational reason why he would do this. To say he would consider such a coalition would alienate Labour voters in Scotland, potentially boost the SNP even further and the more seats they have the more power they will have in any coalition. Scotland has historically been a Labour stronghold and Miliband is trying to salvage lost voters.

Nevertheless, Miliband would be crazy to decline this offer on Election Day if he does not have a majority. It would automatically make him PM and put Labour back in power.

This could perhaps see one of the worst market reactions. Not only would a Labour government come back – which is seen as anti-business – but the Scottish independent agenda would also resurface and we have already seen the damage to the GBP this caused last year.

Odds on a Labour | SNP coalition: 6/1

Labour & Liberal Democrat coalition

This remains a fairly distant possibility. Whilst the chances of the Lib Dem’s winning enough seats to make them kingmakers in coalition talks is optimistic at best given their fall in support, I expect they would prefer a coalition with the Conservatives than Labour.

Nevertheless, the success of coalition talks are based on the conditions each party agree on. Remember, the existing government has the first opportunity to form a coalition and then the other parties can try. Labour failed to agree terms with the Lib Dems in 2010.

So this remains a possibility as there are many within the Lib Dem party who are strongly opposed to another coalition with the Conservatives and would favour joining with a centre left party as opposed to the centre right.

A Lib Dem coalition with the Labour party would be seen less favourably in the markets given the Lib Dem’s attitude to the pro-business measures the Conservatives tried to get through in the previous parliament. But again, this election could also see some of the most senior figures from the Lib Dem side in the last coalition lose their seat, so we simply don’t know what makeup the Lib Dems will have after May 7th.

Odds on a Labour | Liberal Democrats coalition: 12/1