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From the Floor: Tories could be headed for weak majority — #SaxoStrats

   • UK Conservatives likely to win a majority, but smaller than expected: Jakobsen
   • Overall the market is overconfident about Tory victory: Jakobsen
   • Triple-risk Thursday: UK election, ECB meeting, Comey testimony
   • Oil market pausing a bit; Qatari problem not going away: Hansen
   • Big API crude oil decline offset by surprise rise in fuel stocks
   • WTI finds support below $47/b, needs to break $48.75/b to attract short-covering
   • Chinese equities up 1-2%, outperforming other Asia-Pacific equities
   • Australian Q1 GDP growth better than expected at 1.7% y/y
   • AUDUSD tests above 200-day moving average

Saxo Strats banner
By John Acher

Britain’s Conservative party could be headed for a narrower-than-expected majority in Thursday’s general election, and financial markets seem to be overconfident of prime minister Theresa May’s chances of victory, says Saxo Bank’s chief economist Steen Jakobsen on the eve of the vote.

May called the snap election expecting a big victory that would strengthen her mandate to negotiate the UK’s exit from the European Union, but things have not turned out the way she planned, as the Tories’ lead in opinion polls has all but vanished as election day approaches.

“Overall, going into this, there will be a negative surprise if you believe in a Tory landslide,” Jakobsen says. “The Tory party is and has been running a terrible campaign overall.” 

Jakobsen says he favours the polling model used by YouGov, which indicates a very narrow majority for May’s Tories.

“I think she will have a majority – it will be smaller than expected – and she will look long in the face winning this election, because she went in trying to have a stronger mandate for trying to negotiate Brexit,” Jakobsen says. “What is really important is not the UK election, I am sorry to say, but it is how the Brexit talks start and close.”

Jakobsen gives the Conservatives a “C-minus for executing their campaign,” noting that May failed to make a commitment not to change taxes, is proceeding with plans to cut the police force by 16,000 despite recent terror activity, and has taken a stance that no deal on Brexit is a possibility. 

“She has been playing this safe-pair-of-hands policy, which we saw in the French election, in the US election, and it never works,” says Jakobsen.

In contrast, the Labour leader Jeremy Corbyn has “come back from the dead so to speak” with a Trump-like bundle of empty promises, money for everyone, and he has managed to energise young voters and female voters.

“But the problem is that he doesn’t have a commitment to Brexit, so put him in in 10 Downing Street and 11 days after the election you’ll have a prime minister who is not able to navigate anything in terms of international politics,” Jakobsen says. (Read also Michael McKenna's analysis of the UK election here on TradingFloor.)

“I think the bigger trade probably is to be long euro-sterling – Europe still has higher growth than the UK, it is in a better position current account-wise,” says Jakobsen, displaying the following chart from ING Economics showing the possible impact of the election on the pound.

UK Election impact
Source: ING Economics

Volatility has increased as Corbyn has gained in the polls.

“The surprise in sterling could be that the market comes in short sterling contracts in terms of speculative position,” Jakobsen says.

“There is a very high correlation here, so really sterling should be significantly higher based on this,” he says, pointing to the following chart for GBP positioning ahead of the election.

GBP positioning
Source: Bloomberg/Saxo Bank

Sterling has been Saxo Bank’s biggest long position overall, and looking ahead 12-18 months GBPUSD should be at 1.35-1.40, Jakobsen says.

“But short term, we feel that the market is overconfident, as the market has been overconfident over every single election,” Jakobsen says. “So a 1% to 2%, if not a 3%, correction over the next seven days is my most likely outcome of a narrow [victory comprising] probably the same majority as she has now.”

Triple-risk Thursday
Financial markets face a triple whammy of risk on Thursday, with the UK election, a European Central Bank meeting and testimony by the former FBI director James Comey to a US Senate committee.

“The flavour I’m getting is that Comey will dispute Trump’s interpretation that he was not under investigation,” says Saxo Bank’s FX strategy chief John J Hardy. “That sounds negative for the president, but, on the other hand, other sources from Bloomberg are saying that there was no direct order for Comey to cease and desist on his investigation of his embattled national security adviser Flynn.”

(Read also Hardy's latest FX Update here on TradingFloor.)

Oil pauses

The oil market has paused a bit ahead of an important inventory report from the US Energy Information Administration later this afternoon.

A report from the American Petroleum Institute on Tuesday showed a big decline in crude oil stocks, but a surprise rise in fuels.

“The problem is really that if we do see a big rise [in fuel], then we are just seeing inventories being moved from one tank to another, and that is not helping the rebalancing process,” says Saxo Bank’s commodities strategy chief Ole Hansen. 

“The Qatari problem has not gone away,” Hansen says, referring to the spat that pits Iran, Russia and Qatar on one side against other oil producers, including the US, on the other.

“In the short term, the market has taken the view that the first thing that could happen, if we see an escalation, is that the deal to cut production is breaking down, and that could add some additional supplies in the short term, and that could be a negative” Hansen says. “But there is a geopolitical risk there as well that needs to be taken into account.”

WTI crude oil is finding support below $47/barrel, and it needs to break above $48.75/b to trigger short-covering, Hansen says.

WTI finding support 
WTI oil price
Source: Saxo Bank
“Short sellers have been the main drivers of the market recently, in both directions actually, and before a break above $48.75, I don’t think there is going to be any major incentive to cover shorts at this stage,” Hansen says.

The rally in gold has paused, with support seen at $1,282/oz and an initial upside target at $1,315/oz, he says.

In the Asian equity markets, Chinese shares outperformed the region’s other bourses, up 1-2%, driven by consumer products and information technology, says Saxo Bank’s Tareck Horchani in Singapore.

Australian first-quarter GDP growth of 1.7% year-on-year beat expectations, and gave a boost to the Aussie dollar.

“One of the few movers overnight, awaiting all the big events tomorrow, is the Aussie – it’s pushing up to the 0.75 area, which I see as the real key here” says Saxo Bank’s Hardy. "Very few positive drivers."

Theresa May
 Prime minister Theresa May has seen a big lead in the polls 
all but vanish as June 8 election day nears. Photo: Shutterstock

John Acher is a consulting editor at TradingFloor


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