To say the announcement of a general election was a surprise would be an understatement. Downing Street had categorically ruled out an early vote and Prime Minister Theresa May insisted she was getting on with the job.
The EU referendum might have been a disaster for David Cameron but it was a triumph for Theresa’s Tories overall. The party’s grassroots, leadership and the right wing press were united for the first time in a generation. Why risk everything when things could hardly be better?
If this moment in British history is all about Brexit, then the election is surely about ensuring a parliamentary majority consistent with seeing that project through. Like it or not, May is in the book to deliver a “clean Brexit” and, while the going has been good so far, there was no certainty she could get across the line with a majority of just 17.
An anti-Brexit vote?
The election looks to be a slam dunk for the Conservatives, with the vagaries of constituency voting the only source of uncertainty. Some have argued tactical voting among the 48 per cent that chose to remain could stop or soften Brexit, but the whole idea of a challenge looks to have come too soon.
The economy is still good, there is no credible leadership or platform for remainers to stand around and many of those who voted as such just want to get on with it.
In the short term, sterling is likely to be the main conduit for all this, with markets interpreting May’s greater room for manoeuvre as increasing the chances of a soft Brexit.
This may be a step too far, however. May might have been a remain campaigner but that does not translate into sentimentality for the single market. Her version of Brexit is to leave the single market and customs union, end the European Court of Justice’s UK jurisdiction and have only limited future payments to the EU.
Neither has May shown much inclination to compromise. Witness her refusal to exclude overseas students from the immigration figures. In the event of a post-election bounce, I would therefore take the opportunity to sell sterling.
Where this gets interesting is looking at sterling against different currencies. The fundamentals argue for sterling gradually depreciating against the US dollar. Interest rate differentials are a significant long-term driver of currencies and are likely to increase between the UK and US, with the Fed raising rates and the Bank of England hoping to sit on its hands. This would be positive for UK large-caps, whose earnings are dollar denominated.
Valuation, on the other hand, favours the pound. The US dollar is overvalued on most measures while sterling, after a big move last year, looks cheap.
European growth is forging ahead and it increasingly looks like the European Central Bank will have to move to a less accommodative monetary stance. Any change, but especially a change in interest rates, would be positive for the euro.
Meanwhile, the Bank of England is likely to remain on hold, especially as there are signs that the slowdown in the housing market is spreading beyond London. That said, politics in both the UK and Europe could upset the apple cart and require careful attention.
The UK economy could also be affected by a wider review of policy as Brexit goes through. The Great Repeal Bill will pass EU law into UK law using so-called Henry VIII powers, giving the Government significant authority to reshape British law without facing the usual levels of parliamentary oversight.
Used aggressively, these powers could reshape laws governing consumer rights, labour markets and environmental standards, and improve the supply potential of the UK economy. For the meantime, though, I would avoid UK small-caps. Reforms take time to have an impact and rising inflation is likely to eat into consumer spending over the coming year.
A strange election
This election was always going to be a strange one. It confirms what we already know, while tempting investors to listen to the surrounding noise. May will probably win an increased majority. Sterling should benefit in the short term but face a more difficult medium-term outlook. The FTSE 100 should do well from the sugar high of weaker sterling, with the FTSE 250 likely to do worse as the consumer comes under pressure from higher inflation.
Is there any chance of Brexit not happening under May? Some believe public support will evaporate if the going gets tough. A breakdown in talks cannot be dismissed and would put huge pressure on the Prime Minister, even if she has previously insisted that no deal would be better than a bad deal. Europe has plagued the Conservative Party for a generation and it is not over yet.
Bill McQuaker is portfolio manager on Fidelity’s Multi Asset Open funds