Just as international investors were desperately studying up on French politics, it now looks as though they need to read up on the UK as well. They should perhaps wait at least another week until doing so.
The UK snap election came as a total surprise for the good reason that Mrs May had repeatedly assured that she would not call one. The initial market reaction was emphatic with UK stocks and the pound sterling continuing their inverse relationship — the currency had a great day after the news, while the stock market had its worst since the day after the Brexit referendum.
Over the short term, the reaction of sterling had more to do with the way investors were positioned than anything else, and implies little or nothing about where it will go next. As Deutsche’s Alan Ruskin pointed out, there have only been 30 days in the floating exchange rate era when the pound has appreciated more than 2.25 per cent against the dollar in a single day. The average change for the day that follows is a decline of 0.1 per cent. The last four times the pound had this good a day, it rose twice on the next day, and lost twice.
However, sterling had been rising on generally hopeful indicators — such as a surprisingly strong UK economy and an apparently more dovish Federal Reserve, and has now moved above its 200-day moving average, a very important technical indicator of the trend in the mind of forex traders. Also note that traders were overwhelmingly “short” sterling, creating the opportunity for a classic “short squeeze”. This could imply more upside to sterling for the time being.
In terms of ongoing uncertainty, the election itself should not create any, and should instead reduce it. A prime minister who already commands a majority only calls an election three years before they have to if they are totally confident that they will win. The latest polls suggest that Mrs May should, indeed, be confident; the chance that the Conservatives fail to win a majority is higher than zero, but not by much.
Meanwhile, Sunday’s French presidential election first round remains much more of a flash point. Four candidates have a realistic chance of making the two-person run-off in the second round, and all are bunched around 20 per cent.
According to analysis by Vanda Research, there is an 11 per cent chance of a market nightmare run-off in the second round between the hard-left Jean-Luc Mélenchon and the hard-right Marine Le Pen. This would guarantee seismic changes in France’s relationship with the EU. But there is also a 13 per cent chance that neither make it to the second round, and a very strong probability that the centrist Emmanuel Macron emerges the victor.
As Vanda points out, a Donald Trump presidential victory was rated a 13 per cent shot only two weeks before the US election by Nate Silver’s fivethirtyeight.com, so the chances of a French nightmare are too high for comfort.
The odds are that by the beginning of next week, the French electorate will have given international investors a chance to relax. But there is an 11 per cent chance that they will have rendered the UK election close to irrelevant, in market terms, for virtually everyone outside Britain. It might be wise to wait another week before agonising too much over UK assets.
Once the French people have spoken, the issues for the UK will remain complex, and there is a lack of precedents to guide us.
A number of commentators have already said that the chance of a “soft Brexit” — maintaining close trading ties and avoiding an abrupt split from the EU — would increase. They may be right, but that is not clear yet. Over the next four months, I suggest we should monitor four factors:
First, what does Mrs May actually want? At present, she seems enthusiastic for a hard Brexit. It would be unwise to assume that a stronger prime minister would mean a softer Brexit, even if she officially backed the Remain camp in last year’s referendum.
Second, what will be the balance of power within the new parliamentary Conservative party? There are strong anti-European and pro-European factions; will either remain large enough to crimp Mrs May’s freedom of movement?
Third, what will be the composition of the new parliament? If people who voted Remain vote tactically against sitting Conservative MPs, Mrs May could fail to win a significantly stronger mandate. Voters appeared to vote tactically to keep Labour out in the general election two years ago, so this cannot be discounted.
Fourth, the UK is not the only side in the negotiation. The rest of the EU will continue to be in a stronger negotiating position, even if Mrs May gains a stronger mandate, and European politicians may be unamused by what looks like a piece of political opportunism.
Where does that leave investors? Learn the lessons of the last year, and do not try to take any big positions ahead of major political risks. The likelihood is that the situation will be far clearer in two months’ time — those without a huge appetite for risk can afford to wait, and allow braver souls to try to do better.