Market comment: Markets calm as UK voters turn away from Conservatives

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The result of the UK snap election, called by Theresa May seven weeks ago, has ended differently than she had planned. In the midst of UK political uncertainty, markets remain calm.

In a race that became closer than expected, the Conservatives have seen their number of seats in the House of Commons decline. Not only was May denied the “mandate” she sought to strengthen her Brexit negotiations, her Conservative Party has lost the absolute majority. The 650 seats of the House of Commons is divided as follows:

Conservatives
318
Labour
262
Scottish National Party
35
Liberal Democrats
12
Democratic Unionist Party
10
Others
13

British pound lower, other markets largely unaffected
The calm in markets seen before the election continues. On the early news of the election results, the British pound dropped modestly, as political risk is now being priced-in. Markets in Asia opened higher and European equity markets are unchanged or moving higher. Bond markets are also steady. Despite the unexpected election result, we expect the vote to have little medium-term impact on markets.

What about Brexit?
Brexit has not been turned back, but it could well now be different. The hand of the UK is likely weakened and that of the EU strengthened. Brexit negotiations are expected to begin in two weeks and will likely take two years. There is therefore still a long way to go. Not only was the Conservative Party among the losers, so was the Scottish National Party. This lessens the risk of a split of Scotland from the UK.

Investment Outlook
Global equity market fundamentals remain strong, although in the past weeks and after a positive first-quarter earnings season, there has been a slight turn to more defensive sectors. But it was not so much the UK elections weighing on markets as much as the combination of the Trump administration’s false starts with policy, the ongoing Russia probe and timing of central bank policy decisions. As a result, after several weeks of a gradual rise, a more cautious mood has emerged in equity markets, with safer parts of the market benefiting.

Bond markets are also relatively unaffected by the UK outcome. Bond yields have sagged recently in both the US and Europe, but that, again, is not owing to UK politics, and instead is due to unconvincing macroeconomic data and falling inflation expectations. Relative to the UK vote, Gilts are not expected to be largely affected, and, instead, to continue trading sideways, driven more by fundamentals than politics.

Conclusion
It has been another unexpected election result in the UK, following on the original vote to leave the EU a year ago. The gamble by Theresa May to hold a snap election has failed. This time around, the market’s reaction is totally different. The impact is more political than economic. While UK political events over the next six months may cause temporary nervousness, the market’s strong fundamentals and continuing momentum are not expected to be disrupted.


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