Since April 14th, the odds of a hung parliament have risen from 40pc to 60pc.  I have no reason to doubt the veracity of the FT’s survey of investors: given all they have to worry about, no doubt they would prefer to be able to drop ‘political risk’ from the list, and would prefer undivided power in the hands of either Labour or Conservatives (note: the survey does NOT find they favour Tories).

But market action since the debates has done little to suggest a hung parliament spells Panic and Doom.  Yes, today the pound is down against the dollar:

Though less against the Euro; a lot of this is a flight-to-dollar move following the Goldman Sachs news (you have to invert this graph: downward pointing = sterling strength).

Medium term gilts are also relatively untroubled:

and the expectations for interest rates in the next 18 months suggest weaker rates (you have to take this number from 100; the graph is for September 2011, interbank rates).

So what do I think is going on? The mild currency weakness alongside lower rates for the near future suggest to me that the markets think monetary conditions will be easier than they would otherwise have been.  Depending on whether this is a demand- or supply-led movement, we can’t say for certain that this means X.   It would be unrealistic, in my view, to suggest that the markets expect greater fiscal tightening than before (which might achieve lower future rates and lower sterling  by cutting the government’s demand for borrowing, and depressing the real economy so that it too has little demand for borrowing); the workable Tory majority scenario has receded.

Could it mean more QE in the near future?  Hard to say: none of the parties has said much about this, so it is difficult to map onto a political movement.   Greater toleration for higher inflation in the future?  Quite possibly.   I would like to see the figures from the Bank on this.

But none of them are reasons to panic.   That old cliche of the panic stories, the FTSE, is more affected by the lack of air activity and Goldmans than anything political, and remains massively up in the last year.

(UPDATE: Ed Conway has done it much better here)


7 thoughts on “Desperately searching for Panic

  1. Various points, in no particular order;

    FTSE is not really a “UK” stock market any more. It is dominated by a few big companies, and 80% of FTSE revenues come from abroad. Stock markets in general though, are, as you say, up this year. There is a function of having been oversold, and growth looks better as people rebuild inventories and re-hire after over-firing, as well as an element of growth….but the real driver of most western stock markets has been QE.

    Pension funds have been selling bonds into QE, and that money has to go somewhere….given the implicit garauntee many companies now seem to enjoy from governments, the obviousl place has been stocks. We’re jsut building another bubble.

    Short Sterling really is a short term rate, related to the BoE base rate. That it is rallying suggests that the market thinks the economy is going to remain weak, and the BoE will remain on hold longer.

    Gilts are standing pat for the moment, but haven’t traded particularly well if you look at the numbers. Before QE they were at 3.70%, and after QE bought the entire years budget deficit and some, they now trade 4%. Not a good sign. THe market is really jsut waiting for the election results now. WIthout a serious fiscal consolidation though, Gilts are as close as you can get to a one way bet….even with a massive fiscal consolidation they look pretty rich.

  2. @Tyler: “The market is just waiting for the election results now.”

    Exactly. Either they had priced in more political uncertainty* than the betting markets had before the Lib Dem surge, or they don’t see much difference in economic outcomes regardless of who wins the election (or if there is no clear winner). Either way, the Tory argument that a hung parliament would cause economic Armageddon is clearly bunk.

    There was an interesting letter in the FT a few days ago (which Giles linked to) saying that the last time there was a hung parliament (the Lib-Lab pact from 1976-78) it actually improved fiscal discipline because Labour had to get the Liberals to agree. I suspect the same thing would happen (economically – I’m not predicting another Lib-Lab pact!) after 6 May if there is no overall majority, especially since Vince Cable has made more concrete proposals about what to cut to get rid of the structural deficit either Darling or Osborne. (See the Lib Dem manifesto for the first £10bn itemised, then the pamphlet he wrote for Reform in a personal capacity not so long ago for more.)

    *I say “uncertainty” rather than “risk” because I agree with Skidelsky’s criticism that the actuarial concept of risk has been extended far too far, to areas that we have manifestly too little information about to assign a sensible probablity distribution to outcomes. While political punters give a good stab at assigning probabilities to measurable outcomes like numbers of seats, the policies that result from such outcomes are far from clear. After all, Labour’s 1997 manifesto promised a number of things that were never delivered despite an overwhelming mandate. (Cough! Electoral reform!)

  3. We have debated this point before, Tyler. However, the pension funds were not net sellers into QE. It was the hedge funds who were net sellers into QE, the pension funds can’t be anything other than net buyers. They even bought up a sterling bond issue that Finland issued a few weeks ago.

    With a late equity rally on Wall Street and a dollar sell-off. Sterling is only around 40 pips down on the Friday close, which is hardly armageddon stuff. What nobody really knows but today was probably quite revealing is how much of the hung parliament is already priced in to sterling.

  4. @ Nikas

    I think most bank traders are simply waiting to see what happens with little risk on. The election betting still has the Tories much further in front than the polls do, and most of these guys trust betfair more than some pollster – it has quite a good track record (its a very real kind of poll, in a way). That all said, rates would have been a lot higher without QE, which needs to be reversed, inflation is a problem, there is a lot of issuance coming and base rates are already as low as they can go so there are few if any net long positions left out there – the upside to that trade is simply not big enough now.

    @ Richard W

    Yes, pension funds can be net sellers, despite being long only/real money. They might be net buyers of assets, but as long as they don’t breach whatever allocation paramters they are set they can do what they want within that. Yes, there have been large net sales of Gilts from the pension fund industry.

    The hedge fund industry is tiny in the Gilt market in comparison to the real money side. They don’t have enough capital, and wouldn’t usually deploy that capital on low yielding debt anyway – they would only ever trade futures (leverage) or some sterling credit product to get a bigger return than you would from Gilts. Hedge funds might have sold Gilts into QE< but they will have been net shorting the market outright, rather than selling long term positions.

    As for sterling – why are you looking at a one day move? Sterling already has collapsed since the crisis broke, much worse than the move after leaving the ERM. The question now is more does it move again if the UK gets intself into a Greek style debt crisis.

  5. Tyler, the relevance of the one day move was that Giles often follows sterling after the weekend polls. As you say, Betfair is an excellent futures market and a hung parliament moved to odds on at the weekend. Therefore, considering that sterling did not do much suggests to me a hung parliament is very much already priced in.

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