Anyone who's been trading the FX markets in the past six months will know just how much volatility has increased and people who haven't noticed this must have had their head buried in the sand. Cable traders in particular will have been experiencing heightening levels of volatility as investors fear the worst ahead of May's General Election. The market never forgets and it was not long ago when investors were caught off guard by the prospect of a United Kingdom on the brink of splitting as Scotland threatened to vote for independence. The ramifications of Scotland splitting from the UK were not fully considered and the costs of the vote going the way of independence would have been far greater than most moderate estimates had predicted, especially now that oil prices have fallen off a cliff.
With 650 parliamentary seats up for grabs and a majority of 326 needed to guarantee the keys to Number 10 Downing Street, there's a fight to be won as neither of the two main political parties (Labour or Conservative) look like they are going to win outright by achieving that 326 threshold. This means that another Coalition of some form will need to be cobbled together or the other alternative is for a minority government to form and try to run the country, the latter scenario would unlikely last long and another election would probably follow soon after.
Currently the polls that are gauging voter intention indicate that even a Coalition will be hard to come by with too many variables making this scenario difficult to predict as well, with so-called insurgent parties mudding the waters. This makes the coming weeks potentially rather dangerous for investors and traders as geopolitical uncertainty increases. Already we have been seeing an uptick in volatility, not just in sterling, but across FX markets as a whole and if the result from the General Election continues to look like there is going to be no clear winner then things could become even more volatile. Markets' worst enemy is uncertainty and we will have this in abundance should there be no outright winner with enough Members of Parliament to form a majority. You only have to cast your mind back to 2010's election when it took around five days for a government to be formed. On the day of and following the 2010 election GBPUSD traded in a range of 4.4% or nearly 700 points giving a taste of what could happen should a similar or even more unclear result emerge on 8th May, the day after polls close.
But there are other threats to stability in the markets. Despite it currently being unlikely, in the event of a Conservative government with an outright majority being formed, investors would have to factor in the prospect of a referendum on the UK's membership of the European Union. This could lead to a significant rise in sharp FX movements and a big sterling sell off as the uncertainty surrounding the formation of a UK government would be totally dwarfed by the prospect of leaving the EU altogether. Even though the most recent polls conducted on the "in or out" EU question show more support to stay in the EU, a significant sterling risk premium has to be factored in if a referendum becomes more likely.
As the campaigning gets underway in earnest all eyes will be firmly on the polls of voting intentions to see if either party starts to get the upper hand. As we saw in last year's Scottish referendum, these polls have the potential to influence movements in sterling as well. Whilst the outcome is uncertain, an increase in volatility is more assured and almost every possible outcome of the election suggests that any upside to sterling could be limited.
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