How to trade the UK election

With a snap election coming in June, it is worth looking at different possibilities and what impact they might have on the markets.

Downing street
Source: Bloomberg

Theresa May’s decision to call another general election caught many off guard, especially given how many times she categorically ruled it out. However, this seems to be an opportunistic move aimed at taking advantage of Labour’s perceived weakness to ensure the next election is sufficiently far away from a general election.

Whatever the reason, traders will be trying to ascertain exactly how this will impact the markets, and much of that will be down to how the polls progress in the lead up to the event. Pollsters haven’t had the best time over the past year, with the EU referendum and US election results both confounding expectations. The UK election was similarly surprising as no one had been calling the majority achieved by the Tories.

Irrespective of prior transgressions, the markets will continue to rely on polling firms for a gauge of how the election is progressing. For now, it looks like a whitewash for the Tories, who are expected to pick up a whole host of seats from the likes of Labour and the SNP.

This brings us to the associations between different outcomes and what it could mean for the markets.

Conservatives – an increased majority for the Conservatives is the current expected outcome if polls are anything to go by. Given the strength we have seen in the pound since Theresa May called the election, it is clear that markets believe this is a good thing. The reason for this is that by gaining more seats, May will have greater authority and will find it easier to push through the terms of UK’s exit from the EU. Arguably, however, the decision to delay the next election until 2021, while also minimising the pushback on her negotiating outcome could be seen as negative. What this will do, is make things more predictable and less susceptible to vocal pockets of opposition within her own party.

Labour/Lib Dems – in essence, this vote is on Brexit negotiations for the markets. With that in mind, a smaller majority, or a coalition for the Tories will be seen as a bad thing. It introduces confusion and uncertainty into the Brexit process. Lib Dems oppose Brexit as a whole, while Labour seems to still be defining exactly what it would strive for in Brexit negotiations. While a second referendum under the Lib Dems would be positive for the pound, should it choose to reverse Brexit, there is very little chance it will happen. Instead, strength from other parties would simply reduce the conviction within the house and would make it more difficult to get anything passed within the two-year timeframe.

SNP – the SNP have done a good job of relating everything back to the need for a second Scottish referendum vote in recent years. However, recently they are quick to row back on that rhetoric, as they said that the election results will not be a vote which reflects the desire for a second referendum. Given that the SNP seem to only ever care about getting that vote, it is hard to believe that anyone could think a vote against or for the SNP is not a reflection of a voter’s desire or dislike of another referendum. The last election saw an incredible outperformance from the SNP, which looks unlikely to be repeated, with the Tories expected to pick up a great deal of their seats. This should be good for the pound, as it would weaken the case of a referendum, and would lower the likeliness of Scotland leaving the UK in the event of a vote.

The number one market to keep an eye on here is the pound, which is highly sensitive to economic and political shifts adjustments. It is key to watch out for market reactions to any adjustments in polling figures as a gauge of how things might pan out in different circumstances.

An interesting market to trade around this event is GBP/JPY, with a strong Conservative win expected to spark a rally in the pound, amid the greater perceived political stability (negative for the yen). The weekly chart below highlights the bullish wedge breakout we have seen this week, with the price seemingly headed for a significant amount of upside should things play out as expected. Given the downtrend seen in 2015/16, there is a large amount of ground to make up. Watch out for the ¥144.79 resistance level as the next key hurdle to overcome.

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