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After a fascinating and absorbing election campaign, the UK gets to vote on their future Prime Minister, political party and Brexit negotiator for the next five years. The surprise snap election called by PM May seven weeks ago on expectations of a landslide victory has been anything but a victorious lap around the country. Labour and Jeremy Corbyn especially, have run an unexpectedly confident campaign and May’s seizing of the (election) day has been increasingly called into question the longer the campaign has gone on.
Of course, the polls have narrowed over the past few weeks and talk of a hung parliament has gained some traction. With this, the options markets have followed this narrowing too and 1 week Implied Volatility in GBP has doubled to 14% with demand for GBP downside protection driving much of this activity. We also note that trade-weighted sterling has followed the fall in the Government’s poll lead. However in general the markets are still relatively sanguine, predicting instead a comfortable Conservative victory. Indeed, it is notable that investors bought more protection after PM May’s Lancaster House Brexit speech in the middle of January.
The polls then, are being dismissed slightly as most in the markets are prepared to discount a hung parliament. Many are pointing to the fact that opinion polls tend overestimate Labour support in the final weeks of an election. In addition, the approval rating of the leader is a better guide for the winning party than the opinion polls. What is commonly thought of as being key today will be the turnout and that of young voters who tend to favour Labour. The shy Tory factor is also potentially an interesting factor to watch, together with the intentions of previous UKIP voters in their northern heartlands. In any event, the key number to watch will be 326+ seats which will then determine the size of a Conservative majority.
Cable has been stuck in a 200 point range, more or less, since the call of the election, between 1.28 and 1.30. The most recent push through the December 2016 peak at 1.2775 ended previous multi-month bearish consolidation. We look at the three most likely scenarios to play out:
- MOST LIKELY
The first is a Conservative win with a 30-50 seat majority, this being a small increase in their parliamentary majority. We guage that this is the minimum the markets are expecting and would expect a small relief rally due to election uncertainty subsiding. This result may not be enough to break the topside of the recent range and focus may turn to the upcoming Brexit negotiations which are presumed to be difficult, initially at least.
- POSSIBLE
The second (Scenario 2) is a large Conservative majority with 100+ seats. Expectations would be high for a ‘smooth’ Brexit where the new PM is not driven by the Conservative Brexit hardliners. After much price consolidation, cable would see a more substantial rally breaking the 1.30 range and so targeting 1.31 and above. Prices would then be in the previous post Brexit range of 1.31-1.34.
- OUTSIDE BET
The final scenario (Scenario 3) is a hung parliament with a tiny Conservative majority. This would be a shock to markets and cable would sell off aggressively. A harder, bumpy (and possibly delayed) Brexit would follow and PM May would most certainly look like a wounded animal in this event. Any notion of a Labour minority government would lead to massive uncertainty to begin with, though the markets would recover well if a ‘softer’ Brexit were to emerge. Bargain hunters will certainly be lurking around 1.25 in cable with 1.20 the definitive barrier.
GBP/USD Daily Candle Chart
All eyes will be on the exit poll-based projection at 10pm and the overall result should be clear between 3am and 5am. An enthralling night is ahead of us with a break of the current cable range the clear point of interest in FX markets.
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