How not to trade the U.K. elections

One month after each of the last six U.K. General Elections, the average return of the FTSE 100 has been 1.85 percent. Meanwhile, sterling has fallen by an average of 3.06 percent against the U.S. dollar. So the lesson is simple: buy the FTSE and sell the pound, right?

Clearly – not so.

Just as with last year’s volatility in U.K. financial markets sparked by the Scottish independence vote, investors are concerned about what the closest General Election in decades will mean for markets.

There are indeed a few reasons to worry. The economy is fragile, and there is fear that a change of leadership could derail the nascent recovery. There is the threat of a “Brexit” from the EU – and all the uncertainty that would entail – if the Conservatives are returned to power.

And the main problem: it is unlikely we’ll get a clear, decisive outcome, and this could lead to gridlock and inaction in the next Parliament.

These are all reasonable concerns, but they will not have a major, lasting impact on the outlook for British financial markets.

Sterling has weakened against the dollar over most timeframes within the last year, and some reports link that decline to the election.

But for me it has far more to do with the fact that inflation remained at 0 percent in March for the second consecutive month. This has pushed interest rate rise expectations into 2016 for the UK, while they remain in 2015 for the U.S. Furthermore, on a trade-weighted basis, sterling has not even been weak – the U.K.’s main trading partners, who use the euro, have enjoyed a far more pronounced decline against the U.S. dollar.

The Bank of England’s latest figures show that foreign investors have reduced their holdings of U.K. government bonds by £14 billion since the start of the year. But headlines such as “Election jitters prompt gilts exodus” in The Financial Times are misleading. The yield on the 10-year gilt has been falling in recent months – it was close to 2 percent at the start of March, and it now sits below 1.7 percent. Year to date, the yield has also fallen.

CNBC

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Craig Erlam

Craig Erlam

Senior Market Analyst, UK & EMEA at OANDA
Based in London, Craig Erlam joined OANDA in 2015 as a market analyst. With many years of experience as a financial market analyst and trader, he focuses on both fundamental and technical analysis while producing macroeconomic commentary. His views have been published in the Financial Times, Reuters, The Telegraph and the International Business Times, and he also appears as a regular guest commentator on the BBC, Bloomberg TV, FOX Business and SKY News. Craig holds a full membership to the Society of Technical Analysts and is recognised as a Certified Financial Technician by the International Federation of Technical Analysts.
Craig Erlam