Johnson by a knockout: our analysis of the general election; and the perils of year-end repo markets.
December 17 2019
Johnson. By A Knockout.
So UK Prime Minister Boris Johnson has his majority. What were the drivers that went into the result?
Firstly, there was little space for the Conservative Remain rebels, Dominic Grieve, Anna Soubry and Sarah Wollaston being the most prominent examples. These three lost by 27, 10 and 24 points respectively. Not a single one of the former Conservatives took a seat.
Secondly, the Brexit Party turned out to be as much of a threat to Labour as the Conservatives, especially in the Brexit-voting midlands and northern seats. A look at some of the more surprising Conservative victories provides some good anecdotal evidence in this regard. Redcar, for example, went blue for the first time since its formation in 1974. The Labour vote share dropped 18 points from 2017. The Conservatives took around 13 points of that, with the remainder most likely going to the Brexit Party, which came in just over 7%.
Thirdly and fourthly, the Liberal Democrats underperformed expectations, and the Scottish National Party (‘SNP’) outperformed them. Regarding the former, the Lib Dems went from having 20 MPs to 11, in the process providing the night’s ‘Portillo Moment’ when their leader lost her seat. The SNP meanwhile, took 80% of constituencies north of the border.
In terms of market moves we think there are four broad views on the implications of a Conservative majority. In the below table we summarise these views. We would expect these trends to continue, at least across the coming two months, before the June 2020 deadline to extend the transition period comes into view.
Figure 1. Market Reactions to a Conservative Majority
|Asset||Direction and rationale||Move since result|
|GBP/USD||Up – targeting PPP of 1.43||Up as much as 2.7% at one stage, has since moderated and currently at 1.33 (+1.3%)|
|Yields up||Up (regardless of who won given size of both Labour and Conservative spending programmes)||Up from 74bps to 88bps at one stage, since moderated back to 84bps|
|Domestics to outperform exporters. Similarly Value to outperform Growth and Cyclicals to outperform Defensives||Tailwind of strengthening FX, rising yields and pent up underperformance||JPM domestics basket 460bps ahead of exporters (6.5% vs 1.9%)|
|UK to outperform DM||Under-ownership of UK assets since 2016 referendum||FTSE 100 index up 2.6% and FTSE 250 index up 4.0% in local terms. MSCI World index up 0.7%|
As of 13 December 2019.
If the reader wonders about the extent to which we foresaw these themes, we would direct towards our pre-election analysis: A Nightmare Before Christmas: A Primer on the UK Election.
The Grim Repo?
Sparked by a Credit Suisse research note, there is currently some discussion as to whether year-end will herald another spike in the repo market.
The argument is that Basel III has required global, systemically important banks (G-SIBs) to pre-fund their 30-day outflows and liquidity needs. Intraday and resolution liquidity needs must be funded with reserves, but the outflows can be funded with a mixture of reserves and US Treasuries. Banks can therefore only lend using reserves in excess of their intraday and resolution liquidity needs. This in theory is fine, until we realise that the excess reserves of major banks are being lent to other banks to use as collateral for their own liquidity needs to meet their Basel III requirements. Credit Suisse posit that this means that there are no true excess reserves in the system, and that this shortage will make itself felt at year-end, when G-SIBs are forced to report their reserves. The expectation then, is that we hit a similar spike in repo and swap rates to September, which will in turn force a resumption of quantitative easing from the Federal Reserve, as it loses control of overnight funding markets.
In our view, this argument fails to recognise that the Fed’s repo market purchasing in the wake of the September spike was the resumption of QE. Figure 2 shows the rapid decline in the repo rate after the Fed began its purchasing operation in September. If we do see a building spike, we would anticipate that the Fed simply increases the size of purchases, with similar results to before. Indeed, the Fed has since committed to a further USD150 billion of overnight repo operations between 31 December-2 January1. Notwithstanding the valid point that Credit Suisse make regarding the lack of true reserves, we feel our original argument still stands: through repo purchasing, the Fed has the tools to control overnight funding rates.
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As of 16 December 2019.
With contributions from: Henry Neville, (Man Solutions, Analyst), Teun Draaisma, (Man Solutions, Portfolio Manager), Ben Funnell, (Man Solutions, Portfolio Manager) and Andrew Freestone (Man Solutions, Portfolio Manager).