In terms of sheer improbability, the British electorate has just produced one of the blackest of political black swans for markets. Theresa May’s failure to obtain a majority in an election she only called because she was so certain to win in a landslide was extraordinary
But will it have the same drastic and unpredictable effect on markets that last year’s black swans — the victories for Brexit and Donald Trump — had? The answer is probably not, although the risk that Britain’s politicians stage a new version of House of Cards over the next few weeks could yet profoundly change that calculation.
First, note that this result has far less impact on the global stage than the decision to leave the EU did. It certainly pales in comparison with the global impact of Donald Trump.
Second, the change of policy direction would be limited. It looks highly unlikely that Jeremy Corbyn will be able to form a government, and if he does he will not have the freedom to enact his full manifesto programme.
Third, some of the lessons of the last year have been learned, and investors were not strongly exposed to any particular result. Much money was running on a Remain vote, and on Hillary Clinton, last year and this helped drive dramatic market reactions. With uncertainty now high, and the UK facing the possibility of delayed Brexit negotiations, or even a second general election, investors will remain unwilling to take a strong position.
Finally, a perverse factor limiting the reaction is that on the single issue that matters most to the foreign exchange markets, Brexit, Mrs May’s policy was unpopular and regarded as market-unfriendly. Gilts are priced on the assumption that a harmful and “hard” Brexit is a virtual certainty.
People prepared to buy sterling, and other British assets, might now do so in the hopes of a “soft Brexit”. This mitigates the market reaction that might otherwise be expected to a surprising success by an ideological socialist.
In the longer term, however, the risks are skewed to the downside. Delayed Brexit talks would increase the risk of “no deal” or a bad deal. That would be toxic for markets. A second election would herald the possibility that nobody took seriously two months ago, of Prime Minister Corbyn with an overall majority behind him. Labour prime ministers before Tony Blair generally found themselves in a state of war with the foreign exchange markets, and Mr Corbyn is unlikely to be any different.
The distribution of seats in parliament seems to mitigate against anybody putting together a stable coalition. If the old saw of markets hating nothing more than uncertainty holds true, this looks like a very market-unfriendly result. So while the immediate reaction may be more muted, the potential remains for further losses for UK assets, and higher volatility, over the months that come.
For the immediate future, there has already been a notable shift in international equity flows from the UK towards the rest of Europe. So far this year, MSCI shows eurozone shares have gained about 18 per cent, double the gain for the UK, in dollar terms. Surprising European economic strength, plus the reduction in political uncertainty after the election of President Emmanuel Macron in France and defeat for the rightwing populist alternative in the Netherlands, explain much of this. With the UK now thrown into uncertainty, it is reasonable to expect the momentum behind the recovery in eurozone assets to continue, while the UK flags.