No Mayday for UK financial markets

My day here is nearly done, but as we pack up for the weekend we have noticed a few things about price movement on the back of this unusual day for British politics:

FX:                                                                                                                

• GBPUSD’s sell off earlier was sizable, down 300 pips at one stage, however, it has managed to claw back some of its losses, and was actually higher before we knew that Theresa May had managed to form a coalition government with the DUP, albeit with a slim majority. The fact that as we near the close of the European session GBPUSD is more than 200 pips higher than it was before Theresa May called the general election, suggests that pound traders are not in panic mode, and there are some aspects of this election outcome that been viewed favourable by the sterling market.
• The GBPUSD 1-month risk reversal is actually higher on the day, suggesting a drop in the number of traders hedging against a fall in the pound. Thus, traders somewhere are taking the view that the pound could rise in value once the election dust has settled.
• GBPUSD 1 –year risk reversals have backed off a recent high, and have fallen to their lowest level since April. However, this suggests that investors have been curbing some of their enthusiasm for a stronger GBP, rather than getting bearish on the currency. This does not suggest that the market is concerned, at this stage, that the outcome of this election will impact Brexit negotiations in a negative fashion.  
• 1-month volatility in GBPUSD is also subdued, and is well below the average for the last 12 months at 8.12, vs. 10.56 annual average.
• It appears that this election has a few negative implications for sterling, but investors are concentrating on the positive, which include a higher chance of a softer Bruit, something demanded by the DUP before they would join a coalition with Theresa May and the Conservatives, and a reduced chance of Scottish Independence after the SNP lost a number of seats to the Scottish Conservatives. Since Bruit was like kryptonite for the UK currency a reduction in the chance of a hard Bruit could be positive for sterling in the longer term.

FTSE 100:

• The UK index has backed away from earlier highs, but remains well supported at the end of this week, it could even be poised to follow the US indices to fresh record highs in the coming days.  
• However, there have been varied performances within sectors. For example, utility companies such as Severn Trent, Centrica and the National Grid, all threatened with nationalisation in the Labour manifesto, have fallen in unison today. This suggests that investors are continuing to avoid stocks that could be negatively impacted by a Labour government, just in case Theresa May’s fragile coalition topples and Jeremy Corbyn manages to get his feet under the table in the top job in UK politics.
• The top performers today include miners and exporters such as Fresnillo and Smurfit Kappa Group, who benefit from a weaker pound.
• In contrast, the weakest performers were in the real estate sector, which tends to be focused on the domestic UK outlook. These stocks are sensitive to the fall in the pound, and any threat to economic growth from political uncertainty. Retailers such as M&S and Next are also some of the biggest losers today, suggesting that traders are continuing to view the UK’s prospects as diminished, even though Theresa May quickly formed a government after yesterday’s election result.
• It is worth noting that both volume and volatility in the FTSE 100 has remained subdued, suggesting that the UK election wasn’t a key risk event for UK stock traders compared to say the US elections and the Brexit vote last year.

Bonds:

• UK bond yields have been steady over the last 24 hours, suggesting that the large, sensible bond market is not worried by the election outcome. The bond market may have been soothed by the fact that Corbyn’s fiscal plans won’t be put into action (not yet anyway), hence the muted response from bond yields.

Overall, Theresa May has formed a government, but with a very slim majority of just 2 seats. Her new government remains fragile, and popular sentiment seems to be against her. There is a good chance that this government does not last the duration of the Brexit negotiations, but that is a problem for another day.

This election did not spark the imagination of the financial markets, hence the relatively muted response from UK asset prices and the low level of volume and volatility in the FTSE 100 index over the last 24 hours. However, May still has an uphill battle to pass a Queen’s Speech, scheduled for 19^th June. If this fails to pass then it is hard to see how her fragile coalition can survive. Thus, muted volatility in UK asset prices may be on pause and not eradicated completely as Theresa May’s position as Prime Minister continues to look shaky.