The markets are assuming that Prime Minister May should win the UK General Election on 8 June. If recent volatility in sterling signals anything, then Mrs May should be more worried than she is currently showing.
The polling lead she commanded over Jeremy Corbyn in mid-April suggested a Tory party majority of close to 200 seats, but that has now dwindled to an expected 40 seat majority (as measured by Bloomberg). During the final days of electioneering it is wise, as ever, to consider all eventualities.
If the latest polls are any indication of the likely result, a smaller-than-expected Tory majority would be a clear disappointment for markets. Sterling has risen aggressively since May announced the shock election in April. The premise was that an increased majority would enable her to wave the hard(er) Brexit stick at the EU, but also to include the tempting carrot of a transitional arrangement of perhaps a few more years after 2019 of single-market access. With less of a Tory majority in government, a harder, shorter and more uncertain Brexit timeline would be the most obvious outcome, and with this sterling would likely retrace its rise seen since April. This would be good news for large-cap FTSE 100 companies, but less so for domestic earners. The latter, much like the beleaguered UK consumer, will feel the impact of price increases in reaction to further sterling devaluation on their bottom line.
If the polls prove once again to be out of touch with the electorate and Jeremy Corbyn is elected as prime minister, the outlook for both the equity market and sterling would be instantly felt to the downside. The prospect of a government tax raiding UK corporates to support their party’s spending plans would instantly be felt in stock prices. The increased need for additional borrowing would push yields higher in government bonds, and while this might attract some overseas buyers in the interim and support sterling, it is unlikely that this effect would last given the higher borrowing outlook on government finances and more uncertain fiscal position. We should expect sterling to weaken under a Labour government over the medium term.
As investors, we still see downside pressure on sterling post the election as the real issue of negotiating with the EU begins. Consequently, we see a better prospect for capital growth in non-sterling assets. There clearly will be a time to hedge out the currency risk but it’s not yet – the clouds on the horizon are approaching and we aren’t through the storm yet.