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Barclays – UK Surprise: GBP lustre lost

 

Likely slim coalition government raises Brexit risks; we cut GBP longs vs EUR and AUD

·      UK leadership uncertainty to raise near-term GBP volatility with downside skew.

·      Medium-term GBP appreciation still likely, but tail risks of worst-case, no-deal Brexit have risen.

·      Our forecasts are under review and we close GBP long recommendations (vs EUR and AUD).

The Conservatives’ gamble on an early election with a huge poll lead appears to have imploded with negative consequences for GBP as tail risks of a disorderly Brexit have risen. Based on BBC projections, the Conservatives appear to have fallen just short of a majority in the UK parliament, though a slim coalition majority with the Democratic Unionist Party (DUP) of Northern Ireland appears feasible. The key implications of these results, if validated in the final count, are increased uncertainty over the leadership of the UK and a higher, though still likely low, risk of a worst-case, no-deal exit by the UK from the EU. While we continue to see GBP as undervalued and remain broadly positive on it in the medium term, we expect greater near-term volatility skewed to the downside as a likely leadership battle is sorted out in coming months. We, thus, place our GBP forecasts under review and close our two outstanding long GBP recommendations, EURGBP for a loss of 0.83% (entry 0.8710, exit 0.8783) and GBPAUD for a gain of 5.84% (entry 1.6000, exit 1.6935).

Further preliminary thoughts on the implications of the election:

·    PM May almost surely out, but no clarity on replacement for weeks or months: The political gamble by Theresa May likely implies her exit as Prime Minister and Tory leader, perhaps as early as today. There is no clear successor among the Conservatives, and historically, new Conservative leaders have been surprise candidates. Prime Minister May likely would stay on as a caretaker while any possible leadership contest is determined.

·    A50 clock still ticking, raising the risks of a Brexit “crash out”: There is unlikely to be any delay in the Brexit timetable as that would require unanimous consent of remaining EU members. Hence, the Tories’ likely leadership contest will eat into valuable negotiating time before the March 2019 exit. Further, any new leadership will need time to articulate and implement a negotiation strategy. Additionally, as we pointed out in The Coq, the Lion and the Elephant, 4 May 2017, confidence plays a key role in successful negotiation; any new Tory leader will have to be chastened by today’s results. Jointly, these raise the risks of an exit from the EU without a deal, a “disorderly Brexit” that represents the worst case Brexit scenario. While we continue to believe that remains a low likelihood, there is no question the risks have risen and that GBP should reflect that through a lower expected path.

·     Scottish referendum off the table: The biggest loser of the night was the Scottish National Party (SNP), which campaigned in large part on demands for a second independence referendum. The SNP is projected to have lost a staggering 21 of 56 seats previously held and its share of the total vote fell nearly 40%. On the margin, this represents a GBP positive.

·    “Soft” Brexit still unlikely: Labour was the biggest gainer of the election, not “soft” Brexit. The only two parties campaigning on a platform of a “soft” Brexit were the Liberal Democrats (LD) and the SNP, and both saw a decline in their national vote share (although the LD picked up a handful of new seats). The DUP also favours Brexit and is unlikely to challenge the Conservatives on Brexit strategy.

·     Fiscal austerity takes a back seat: Labour’s large gains, particularly relative to the Conservatives, will call into question support for fiscal policy, though as we noted in UK 2017 General Election: Risks priced conservatively, 2 June 2017, Brexit almost surely would dominate the domestic agenda, and a slim coalition government only increases the likelihood of little domestic agenda progress.

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