This morning’s shocking announcement caught virtually everybody by surprise, and is prompting one bank after another to thoroughly revise their cable forecasts, case in point Deutsche Bank, whose strategist George Saravelos just announced he is changing his view on sterling because the “early elections are a game-changer”, something which the market clearly anticipated judging by the surge in cable…
… a surge which will prompt the near record number of GBP shorts to cover en masse.
To be sure, May’s announcement does make sense in retrospect: as Unicredit’s Vasileios Gkionakis notes, May’s logic is sound: “It’s good to have the elections now that you have good U.K. numbers, which are mostly dependent on global growth, because when you start seeing the U.K. idiosyncratic factors filtering through, potentially her popularity is going to throb a bit”
As for Saravelos, his full note below:
Changing view on sterling: early elections a game-changer
This morning’s announcement from PM May of a snap general election on the 8th June is in our view a game-changer for both the UK’s Brexit negotiations and sterling. We argued last year that an early general election was the only way to resolve the political impasse the U.K. government faces in conducting Brexit negotiations. The 2020 General Election imposed a hard deadline on delivering Brexit on an unrealistic timeline as well as making the Prime Minister reliant on a small Euro-sceptic majority. Both of these factors would have required political and market pressure to impose the appropriate political shifts that would have allowed a realistic deal to emerge.
In contrast, today’s general election announcement changes the outlook. We do not see the election as a mandate for hard Brexit. Instead, assuming current polling proves correct, it should result in a larger Conservative majority. This will have three material implications, in our opinion.
- First, it makes the deadline to deliver a “clean” Brexit without a lengthy transitional arrangement by 2019 far less pressing given that no general election will be due the year after.
- Second, it will dilute the influence of MPs pushing for hard Brexit, strengthening the government’s domestic political position and allowing earlier compromise over key EU demands for a
- transitional arrangement.
- Third, it strengthens the PM’s overall negotiating stance who in recent weeks has clearly fallen in line with the European negotiating approach.
This will involve a settlement of the Brexit payments and other divorce aspects first, to be followed by a lengthy transitional period during which the final outcome of Brexit will emerge. This sequenced approach materially reduces the “crash risk” of Brexit negotiations as well as strengthening the Prime Minister’s hand in pursuing an orderly (and very lengthy) withdrawal. All of the above in turn reduce downside risks for the U.K. growth outlook over Brexit negotiations.
We have been structurally bearish on sterling for the last two years but are now changing view. We are closing out all our bearish FX trades. We intend to review our sterling forecasts in coming days.
That said, some disagree. As Bloombergs Richard Jones writes after the announcement, the early election is not likely to shift the dial “much” for investors. Key highlights from his take:
It’s hard to see how an early U.K. election will be a game changer for markets.
The process to leave the European Union has already been initiated with the triggering of Article 50. And polls show the Conservatives will win hands down and return to the government with an increased majority. Domestic politics hasn’t been a great source of uncertainty. It is rather the economic implications of Brexit and the attendant lack of clarity that has ratcheted up consumer, business and investor anxiety.
The clock is ticking, the political dynamics aren’t likely to shift, so investors have no reason to radically alter their views on the implications of Brexit with Tuesday’s announcement.
The longer-term implications of Brexit are perhaps best summarized in a recent paper from the San Francisco Fed, a prognosis not dissimilar to the views expressed by Bank of England Governor Mark Carney.
The lack of access to the EU single market will likely damp potential U.K. growth for years, with Britain both less specialized and less efficient post-Brexit, the San Francisco Fed argued.
If today’s price action is any indication, market moves will probably be noisy during the election campaign. But unless there is any unexpected shift in domestic political dynamics, the issues currently in place will remain after June 8.
For now, however, it’s the short covering panic that is driving price at least for the immediate future.