Markets wise to election script after 2010 unease

It is the eve of the UK election, and the markets are in a state of unease - not just about the prospects of a hung parliament, but about how to view the Greek crisis and what can be gleaned from the US equity "flash crash".

That was May 2010. Five years on, and history has a funny way of repeating itself. Nothing much has changed when it comes to sorting out Greece or trading manipulation. On the surface markets appear to have become more sanguine about election uncertainty in the UK, reflecting expectations that a government will soon emerge after polling day, with problematic political issues well beyond the horizon.

A case in point has been the performance of the pound. During the first five months of 2010, sterling lost 6 per cent against the dollar, and after the election fell a further 5 per cent inside 12 days as the market spurned the idea of a UK coalition government.

Alan Wilde, head of fixed income and currency at Baring Asset Management, recalls how five years ago the prospect of a coalition government "terrified the market".

Half a decade on, sterling has proved far more resilient, and during the course of the election campaign has risen 3.3 per cent against a weakening dollar.

As JPMorgan strategists put it, "sterling's pre-election outperformance has confounded expectations".

A coalition is viewed as preferable to an outright victory for either of the main parties, concludes Mr Wilde. "If a week is a long time in politics, then in five years we've moved a very long way.''

But uncertainty is not far from the surface. In one respect traders are as cautious as they were in 2010, insuring themselves against big swings in sterling crosses, as shown in the five-year high on Tuesday in one-month sterling/euro implied volatility.

Yields on 10-year gilts rose sharply on Tuesday and Wednesday, climbing past 2 per cent for the first time this year, although the move reflected a broader sell-off in global debt markets.

Some investors remain unconvinced that the UK election is having a big impact on the gilts market. Seamus Mac Gorain, fund manager at JPMorgan Asset Management, says most people have "stayed on the sidelines", because of uncertainty over the outcome.

Howard Cunningham, fixed income manager at Newton Investment Management, says gilts may "remain better supported" than sterling, especially those with shorter maturities, because of limited supply and "uncertainty in other domestic asset classes".

Much depends on how the UK economy performs. The backdrop of both 2010 and 2015 campaigns was one of a growing economy. Labour's last Budget before the 2010 election forecast gross domestic product growth of 3 per cent in each of the following two years.

It was "a false dawn", recalls Jane Foley, chief currency strategist at Rabobank. "Little did we know the recovery would take much longer."

Investors are asking whether the economy will splutter after the election. Ian Stannard, head of European FX strategy at Morgan Stanley, says the economy is stable and robust enough to withstand any market worries about the election outcome.

But away from the markets, he worries about the business community, citing a slowdown in merger and acquisition flows into the UK. This, he says, reflects concerns about "Brexit" - the Conservatives' manifesto promise of an in-out referendum on the EU.

"Would a prolonged period of uncertainty [about Brexit] deter foreign investor inflows?" Mr Stannard asks. He is not the only currency strategist to detect increasing anxiety about a Conservative-led administration leading to a Brexit referendum.

According to Ms Foley, it is more of an issue than the impact of leftwing politics on the UK recovery if a Labour-led government comes into power. On that prospect there is "relative ambivalence" among international investors, she says - the polarisation of left versus right is magnified in the UK, but investors abroad see little difference.

Gilt investors also say the aftermath of the election could pose more serious problems. Mr Cunningham points to the prospect of an in-out referendum on EU membership, or the Scottish National party holding the balance of power, as scenarios that would "inject uncertainty" and "hit confidence".

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Five years ago Alan Wilde told the FT on the day after the election that the politicians needed to bring their coalition negotiations to a speedy conclusion.

They will be expected to apply the same rapid pace once the results are known on Friday. A timeframe of "a week or two" would be acceptable, he says. Any longer and the markets will get twitchy.

"The markets may be more relaxed about the idea of a hung parliament than five years ago," says Ms Foley. "But that doesn't mean they welcome the idea of uncertainty, especially if it's for a prolonged period."

Additional reporting by Thomas Hale

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