Britain, France: A Tale of Two Discordant Elections

Unlike the first round of the French presidential elections on April 23, which saw an exciting four-horse race, the upcoming parliamentary elections in the United Kingdom appear to be a one-sided affair. 

Opinion polls, which in the past have often understated the support for Britain’s Conservative Party, are showing the party of Prime Minister Theresa May winning by a landslide on June 8 (Figure 1).  Oddsmakers give her nearly 9-1 odds of being sworn in as Prime Minister on June 30, compared to a one in 10 chance for Jeremy Corbyn, the beleaguered leader of the Labour Party. You can listen to a podcast on this topic here.

Figure 1: It’s Not a Nail-Biter.

Support for the Conservative Party’s erstwhile coalition partner, the Liberal Democrats (Lib Dems), has perked up to around 11% from 7% in 2015, but is still not enough to win any significant representation in the House of Commons.

May’s Conservatives, also known as Tories, currently control 330 of the 650 seats in parliament, giving them a narrow majority.  If May’s party were to win 46% of the vote, the average of the 10 most recent opinion polls, the BBC’s admittedly rudimentary election seat calculator estimates that the party would gain roughly 67 seats, expanding its total to 397 seats.  The gains would come almost purely at the expense of Labour, which would see its support drop from 31% to 25% and its number of parliamentary seats decline from 232 to 164.  

For their part, the Lib Dems advancing from 7% to 11% in the polls should add one or two additional seats at most to their paltry total of eight.  That said, the anti-Brexit, pro-European Lib Dems hold perhaps the only potential to make Britain’s 2017 election exciting: they are the logical home for the aggrieved “Remain” voters in the Brexit referendum who no longer feel at ease among the Conservatives and are furious with Labour leader Corbyn’s half-hearted attempts to keep the U.K. in the European Union.  Even so, the Lib Dems’ support would have to double or triple from current levels for them to have any material impact on the election.  Meanwhile, the Lib Dems ideological nemesis, the UK Independence Party (UKIP), has committed the most grievous political sin by achieving its objective of taking the U.K. out of the EU and thereby eliminating their raison d’être

Given the one-sided nature of pre-election polling and expectations, the potential upside for the pound in the event Tories win in a landslide is limited.  Investors reacted positively to the news of the early election called by May and the possibility of an expanded governing majority, lifting the pound to its highest level since early October but still far below pre-Brexit levels (Figure 2).

Figure 2: GBP is Still in the Dumps.

Longer-term risks for the pound still abound.  While an expanded governing majority will help May to navigate the Conservative Party’s internal divisions over Brexit, it won’t do much to temper negotiations with Britain’s European partners.  The ease or difficulty of the negotiations will have a great deal more to do with who sits on the other side of the negotiating table than it does with the number of seats held by May’s party in the British parliament.  

For a hint of how this might turn out, look across the English Channel to France.  Currently, polls put former banker Emmanuel Macron ahead by roughly 60-40 over firebrand Marine Le Pen in the presidential election, and oddsmakers give him an 80% chance of winning the runoff on May 7.  So far, Macron has taken a hardline position on the U.K. leaving the EU, describing Brexit as a “crime” and suggesting that there will be no caveats or waivers that would allow Britain to have the best of both worlds.  In short, a Macron victory could signal a ‘hard Brexit’ that currency investors fear.

Should Le Pen win the election, there might not be much of a European Union left with which to negotiate a departure.  Although she appears to be far behind in the polls, we would not recommend counting her out.  Already she has begun attacking Macron as a tool of oligarchs and as an out-of-touch Parisian elitist.  While the scandal-plagued center-right candidate Francois Fillon, who got nearly 20% of the first-round vote, has endorsed Macron, his supporters are not guaranteed followers.  Moreover, the far-left candidate, Jean-Luc Mélenchon, who also won nearly 20% of the vote, has thus far refused to endorse Macron as has the pro-French sovereignty candidate Nicolas Dupont-Aignan, who took nearly 5% of the vote. 

While it might be tempting to see the far left as the opposite of what the far right stands for, they in fact have a great deal in common, including an aversion to free markets, investment bankers like Macron as well as deep-seated Euroscepticism.  Over the last several decades, former members of French Communist Party have swelled the ranks of Le Pen’s National Front, and the migration of the far left to the far right appears as though it will continue in 2017.

The upcoming French Presidential debate also has potential to upset political trends and markets.  While Macron is bright and nimble, he will find himself going up against a battle hardened and wily Le Pen.  If he loses the debate, the 20%-plus polling gap currently in his favor might begin to narrow.

In short, the relief rally in the euro and the global equity markets following the first round of the French presidential elections might prove short-lived. Likewise, the complacent state of the pound and euro currency options markets might also begin to change, elevating both currencies to a higher plane of implied volatility from their current rather low levels (Figure 3).  Rather than looking like a lasting respite from volatility, the lead up to the second round might be remembered as the eye of a storm.

Figure 3: EUR and GBP Implied Volatility Still Far from Its Highs.

 

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

About the Author

Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.

View more reports from Erik Norland, Executive Director and Senior Economist of CME Group.