The easy explanation for today’s rout in UK markets - the sell-off in the FTSE 100 and the rise in Gilt yields, which have managed to erase earlier losses, is election fears. The UK is going to the polls as I type this, my vote is yet to be cast, the prospect of a hung parliament is a virtual certainty. While this leaves very few attractive options for the next UK government (Labour/ SNP, or Conservative/ Lib Dems/ lots of small parties), we think that this is one of a number of factors that have triggered market volatility this week.
Why the election is not the chief driver of markets today:
- At its peak today, the FTSE 100 had sold off 1.7%, it last sold off this much on 31st March. Although the FTSE took a hammering earlier, it is not that unusual compared with recent volatile trading periods in the past few months.
- The FTSE 100 also sold off alongside other European markets; I don’t think that the German Dax, with its stable government and non-existent debt levels, would be impacted by an uncertain election result in the UK.
- Likewise with bond yields. UK Gilt yields jumped 3.6% at one stage today; however they have since dropped back and are now 1.29% below where they started at Thursday’s open.
- UK Gilt yields rose by more on 22nd April – nearly 10% - and also had larger gains on 15th and 16th April.
- German yields have also been rising in lockstep with UK yields, in fact the rise in German 10-year yields have outpaced the rise in UK Gilt yields of a similar maturity in recent days (see figure 1). In the last 24 hours German yields are up some 13%, we doubt this has anything to do with Miliband or Cameron.
If the market was seriously concerned about the UK election and the impact it could have on the country’s economy, one would expect it to be reflected in the UK’s creditworthiness. One way to measure this is to look at the UK’s credit default swap, which has remained stable during this election cycle, as you can see in figure 2.
So what is driving the markets right now?
While we wouldn’t rule out the prospect of a hung parliament in the UK hurting sentiment in the days to come, we think that Fed chair Janet Yellen’s warning that stock market valuations are high, while bond yields are extremely low is the most likely reason for the erratic behaviour in the financial markets in the last 24 hours. The fact that yields are rising in tandem across the globe, suggests that tighter monetary conditions could be the bogey man for risk-seekers in the coming months. Whether Miliband or Cameron get their hands on the keys to Number 10 Downing Street may only be a short-term distraction.
As some astute people have already noted, in the US the prospect of a hung parliament is considered a good thing as it could limit political medalling in the financial markets in the years to come. Across the pond, while we wring our hands about the prospect of a multi-party coalition of maybe one or two members, the rest of Europe have been used to fractious coalitions for decades, and it’s still standing…
- UK markets had a sharp sell -off earlier on Thursday, but have managed to claw back some earlier losses.
- This makes us doubt that the election is a key driver of markets right now.
- Stocks fell across Europe at the same time as bond yields rose, which suggests that these moves are not down to the UK election.
- The UK’s creditworthiness has not been impacted by this election.
- The biggest driver of markets could be the Fed’s Janet Yellen who warned about high equity market valuations and low bond yields in a speech on Wednesday.
- Of course, if other drivers have been behind the move higher in UK Gilt yields then an adverse outcome from this election could weigh on UK borrowing costs in the days to come, and could also dent sentiment towards the pound and FTSE. So watch out for volatility as we move towards the weekend.